A7.

Installation cost
# of years
Projected net income:
Year 0
Year 1
Year 2
Year 3

$ 18,000,000
4
$
$
$
$

1,632,000
2,106,500
1,941,700
1,298,000

Average net income

Average book value
AAR

$1,744,550
$9,000,000
19.38%
(a)

A7.2

CFs
A
Year 0
$
(37,000)
Year 1
$
19,000
Year 2
$
14,500
Year 3
$
12,000
Year 4
$
9,000
Required return

$
$
$
$
$

B
(37,000)
6,000
12,500
19,000
23,000
11%
(b)

NPV (A)
NPV (B)
The NPV decision rule implies we accept

$
$

6,588.52
7,594.13
Project B
(c)

Crossover rate

14.25%

IRR (A)
20.30%
IRR (B)
18.55%
The implication of ranked IRR is to accept
Project A
This may not be a correct decision however, because the
IRR has a ranking problem for mutually exclusive projects
To see if the ranked IRRs lead to the correct decision or
not, we need to evaluate the project NPVs.
CF difference
Year 0
$
Year 1
$
13,000
Year 2
$
2,000
Year 3
$
(7,000)
Year 4
$
(14,000)
(1)

A7.3

CFs
A
Year 0
$
(350,000)
Year 1
$
25,000
Year 2
$
70,000
Year 3
$
70,000
Year 4
$
430,000
Required return

$
$
$
$
$

B
(35,000)
17,000
11,000
17,000
11,000
15%

Payback (A)
Payback (B)
Payback criterion implies accept
because it pays back sooner.

Discounted cash flows

Year
A
B
0
$ (350,000.00) $ (35,000.00)
1
21,739.13
14,782.61
2
52,930.06
8,317.58
3
46,026.14
11,177.78
4
245,853.90
6,289.29
Discounted payback (A)
3.93
Discounted payback (B)
3.11
Discounted payback criterion, implies accept Project B
(2)
because it pays back sooner.

(3)

NPV (A)
NPV (B)
NPV criterion implies accept
because it has a higher NPV.

$ 16,549.22
$ 5,567.25
Project A
(4)

IRR (A)
IRR (B)
IRR decision rule implies accept
because its IRR is greater.

16.57%
23.05%
Project B
(5)

PI (A)
PI (B)
Profitability index criterion implies accept
because its PI is larger.
A7.4

Annual cash flows:

Year 0
$
(12,000)
Year 1
$
5,800
Year 2
$
6,500
Year 3
$
6,200
Year 4
$
5,100
Year 5
$
(4,300)
Interest rate

The only decision rule that can rank mutually exclusive

projects is NPV: therefore you should accept

1.047
1.159
Project B

Discounting approach:
Year
CF
0
$ (14,669.96)
1
$
5,800.00
2
$
6,500.00
3
$
6,200.00
4
$
5,100.00
5
$
-

3.43
2.41
Project B

Project A

Reinvestment approach:
Year
CF
0
$ (12,000.00)
1
$
2
$
3
$
4
$
5
$
25,955.28

Combination approach:
Year
CF
0
$ (14,669.96)
1
$
2
$
3
$
4
$
5
$ 30,255.28

10%
MIRR

22.63%

MIRR

16.68%

MIRR

15.58%