Solution for Build a model chapter 12

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Solution for Build a model chapter 12

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You are on page 1of 9

flows are as follows:

Time Project A Project B

0 ($375) ($575)

1 ($300) $190

2 ($200) $190

3 ($100) $190

4 $600 $190

5 $600 $190

6 $926 $190

7 ($200) $0

a. If each project's cost of capital is 12%, which project should be selected? If the cost of capital is

18%, what project is the proper choice?

Use Excel's NPV function as explained in

WACC = 12% WACC = 18% this chapter's Tool Kit. Note that the range

does not include the costs, which are added

NPV A = $226.96 NPV A = $18.24 separately.

At a cost of capital of 12%, Project A should be selected. However, if the cost of capital rises to 18%,

then the choice is reversed, and Project B should be accepted.

Before we can graph the NPV profiles for these projects, we must create a data table of project NPVs

relative to differing costs of capital.

Project A Project B

C

0% $951.00 $565.00

2% $774.82 $479.68 $1,200.00

4% $623.67 $404.81

6% $493.79 $338.95 $1,000.00

8% $382.02 $280.88 $800.00

10% $285.71 $229.55

12% $202.65 $184.08 $600.00

14% $130.94 $143.73

16% $68.99 $107.84 $400.00

18% $15.45 $75.89

$200.00

20% ($30.82) $47.37

22% ($70.81) $21.90 $0.00

24% ($105.36) ($0.90) 0% 2% 4% 6% 8% 10% 1

26% ($135.19) ($21.31) ($200.00)

28% ($160.91) ($39.62)

($400.00)

$200.00

$0.00

0% 2% 4% 6% 8% 10% 1

($200.00)

($400.00)

30% ($183.06) ($56.06)

Note in the graph above that the X-axis intercepts are equal to the two projects'

IRR A = 18.64% IRRs.

IRR B = 23.92%

Cash flow

Time differential

0 $200

1 ($490)

2 ($390) Crossover rate = 13.14%

The crossover rate represents the cost of

3 ($290) capital at which the two projects value, at

4 $410 a cost of capital of 13.14% is:

5 $410 have the same net present value. In this

6 $736 scenario, that common net present $181.59

7 ($200)

e. What is each project's MIRR at a cost of capital of 12%? At r = 18%? Hint: note that B is a 6-year project.

MIRR B = 17.01% MIRR B = 20.47%

Project A

Time period 0 1 2 3 4 5 6 7

Cash flow (375) (300) (200) (100) 600 $600 $926 ($200)

Cumulative cash flow (375) (675) (875) (975) (375) 225 1,151 951

Payback 4.757

Project B

Time period 0 1 2 3 4 5 6 7

Cash flow (575) 190 190 190 190 $190 $190 $0

Cumulative cash flow (575) (385) (195) (5) 185 375 565 565

Payback 3.026

g. At a cost of capital of 12%, what is the discounted payback period for these two projects?

WACC = 12%

Project A

Time period 0 1 2 3 4 5 6 7

Cash flow (375) (300) (200) (100) 600 $600 $926 ($200)

Disc. cash flow 375 268 159 71 (381) (340) (469) 90

Disc. cum. cash flow 375 643 802 873 492 152 (317) (227)

Discounted Payback 5.32

Project B

Time period 0 1 2 3 4 5 6 7

Cash flow (575) 190 190 190 190 $190 $190 $0

Disc. cash flow 575 (170) (151) (135) (121) (108) (96) 0

Disc. cum. cash flow 575 405 254 119 (2) (110) (206) (206)

Discounted Payback 3.98

h. What is the profitability index for each project if the cost of capital is 12%?

PI of A: 1.61

PI of B: 1.36

Chart Title

6% 8% 10% 12% 14% 16% 18% 20% 22% 24% 26% 28% 30%

6% 8% 10% 12% 14% 16% 18% 20% 22% 24% 26% 28% 30%

ar project.

MIRR

To calculate the MIRR,

Calculate the PV of Outflows: (npv(r%, cashflows even the zeros)

Calculate the PV of INflows: (npv(r%, cashflows even the zeros)

Calculate the FV of INflows: FV of the PV of Inflows at r%

Calculate MIRR which is I for PV = PV of Outflows, FV= FV of Inflows, PMT= 0

zeros)

ros)

f Inflows, PMT= 0

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