Project X

Years-1 Cash Recoverable Amount -3 Payback WAAC PV of Cash flows at WAAC PV of Cash flows at
Flows-2 Needed Balance Period 12% A-6 ( 2x5) 19% B-8 ( 2x7)
12%-5 19%-7
Required-4
0 (10,000) (10,000) 1 (10,000) 1 (10,000)
1 6500 6500 3,500 1 year .893 5,804.5 .840 5,460
2 3000 3,000 500 1 year .797 2,391 .706 2,118
3 3000 3,000-500 0 2 months .712 2,136 .593 1,779
3,000/12
4 1000 .636 636 .499 499
Total of inflows 10967.5 9,856
NPV + 967.50 C (144)-D
Pay Back: In how many years Investment is recovered from cash inflows. 2.2 years

NPV + $ 967.50 -----Decision Accept the Project.

IRR-Hit & trial Method = At a rate of discount PV of Inflows = PV of Outflows = NPV = 0

IRR = A + ( C/C-D)x B-A = 12% + 967.50/ 967.50 – (144) x 19%-!2% =

12% + ( 967.50/1111.50) x 7% = 12% + 6.09% =18.09%

A = Lower Trial Discount Rate 19 % - 144/ 1111.50 X 7% = 19% - 0.906% = 18.09%

B = Higher Trial Discount Rate C= NPV of Lower Trial

D = NPV of higher trial

Product Y- IRR Calculation:

Years- Cash Recoverable Payback WAAC PV of Cash flows WAAC PV of Cash flows at
1 Flows-2 Amount -3 Period at 12% A-6 19% B-8 ( 2x7)
12%-5 16%-7
Needed Balance Required-4 ( 2x5)
0 (10,000) (10,000) 1 (10,000) 1 (10,000)
1 3,500 6,500 6,500 1 year .893 3,125.5 .862 3,017
2 3,500 3,500 3,000 1 year .797 2,789.5 .743 2,600.50
3 3,500 3,500 0 10 .712 2,492 .641 2,243.50
months
3500/12=291
.66
4 3,500 .636 2,226 .552 1,932
Total 14,000 Total of inflows 3.038 10,633 9,793
NPV + 633 (207)
Pay Back: In how many years Investment is recovered from cash inflows. 2.10 years

Direct Payback when Even cash inflow = Initial Investments / Annual cash Inflow = $10,000/ $ 3,500 =2. 9 years
NPV + $ 633 -----Decision Accept the Project.

Investment ($ 10,000)

12%PV of 3.038 X $3,500 $ 10,633

NPV + 633

IRR- Factor Method = At a rate of discount PV of Inflows = PV of Outflows = NPV = 0

IRR = F (3,500) = (10,000) or IRR = F (3,000) = (10,000)

PV 15 % 2.855 - F 2.85 = 3.333

RR = F = 10,000/3500 = 2.85 / 2.95 say

B PV 16% 2.798 - 2.95 = D - 0.152

A PV 13% 2.974 - 2.95 = C 0.024

IRR = A + ( C/C-D)x B-A 13 % + 0.024/.176= .024 –(.152) x 3% = 13% + =

IRR = 16% - .152/.176= .024 –(.152) x 3% =16% - = 16% -2.59% = 13.41%

IRR 12% + 633/840= 633-(207)x 4% = 12% + 3.014 = 15.014%

IRR 16% - 207/840= 633- (207) x 4% = 16% - = 15.015% or

IRR 16% - 207/- 840 = -207 - 633 x 4% = 15.015%

Project X (Discounted Pay Back Calculated)

ears- Cash Flows-2 Recoverable Amount - Payback WAAC PV of Cash flows Discounted Payback Discounted Payback
1 Needed Balance Period at 12% A-6 ( 2x5) Recoverable Amount Period Required
12%-5
Required-4 Needed Balance
0 (10,000) 1 (10,000) (10000) (10000)
(10,000)
1 6,500 6,500 3,500 1 year .893 5,804.5 5,804.5 4,195 1 year
2 3,000 3,000 500 1 year .797 2,391 2,391 1,804 1 year
3 3,000 3,000- 500 0 10 .712 2,136 2,136-1804 0 10 months
months =2136/12=178
3500/12
=291.66
4 1,000 .636 636
Tota 14,000 Total of inflows 3.038
l
NPV 967.50
Project Y (Discounted Pay Back Calculated)

Years Cash Flows- Recoverable Amount Payback WAAC PV of Cash flows at Discounted Payback Discounted Payback
-1 2 -3 Period 12% A-6 ( 2x5) Recoverable Amount Period Required
12%-5
Needed Balance Required-4 Needed Balance
0 (10,000) 1 (10,000) (10000) (10000)
(10,000)
1 3,500 3,500 6,500 1 year .893 3,125.5 3,126 6,874 1 year
2 3,500 3,500 3,000 1 year .797 2,789.5 2,790 4,084 1 year
3 3,500 3,500 0 10 .712 2,492 2,492 1,592 1 year
months
3500/12=2
91.66
4 3,500 .636 2,226 2226-1592 0 11.+ months
1592/12=133
Tota 14,000 Total of inflows 3.038 10,633
l
NPV + 633
The following table summarizes the project rankings independently under WACC 12% by each method provided
choice is given to select any one:

Parameter Results- Results- Remarks/Conclusions

Project X Project Y
Pay Back 2.10 months 3.10 months X < Y – Accept X
Conventional
Pay Back Discounted 2.10 months 3.11 months X < Y – Accept X
12 % Net Present 967.50 + 633 X < Y – Accept X
Value
Internal Rate of 18.09% 15.015% X < Y – Accept X
Return- WAAC 12

C) Project X or Y are Mutually Exclusive ( Company faces Budget/ funds constrains then out of two
options Only One Project is selected and will leave second one)

i. Conflicting Situation is due to Results find out on either NPV or IRR Approach (For Example)

Paramete Project X Project Y Result Conflict Analysis of

r Dissimilarities
NPV 546 467 X>Y Which project Invested Funds,
should be Cash Inflows &
selected? Life span.
IRR 16.97% 19.8% Y>X Which project Invested Funds,
should be Cash Inflows &
selected? Life span.
Calculating or Find out the Crossover Rate

The crossover rate determines which of two potential projects is more profitable.  Rate of return (alternatively WAAC)
represents the rate of return at which the net present value profile of project x intersects the net present value
profile of project y that is he rate at which NPVs of two projects are equal.

To determine the effects of changing the cost of capital, plot the NPV profiles of each project.

The crossover rate occurs between 6% and 7% (6.22%).

Calculating Cross Over Point of Two Projects X & Y

Year Project Project Projects PV 10% PV PV5% A 5% PV of

X Y Differences 10% B of cash cash flows
(Y- X) flows
0 ($ 10,000) ($10,000) $0 1 0 0 0
1 $ 6,500 $ 3.500 ($ 3,000) .909 ($2,727) .952 ($ 2,856)
2 $ 3,000 $ 3,500 $ 500 .826 $ 413 .907 $ 454
3 $ 3,000 $ 3,500 $500 .751 $376 .864 $ 432
4 $ 1,000 $3,500 $2,500 .683 $1708 .823 $ 2,058
Total 2,497 $ 2,944
NPV (230)-D $ 88-C

IRR/ Cross over Rates of Project x, y = 10 % - (230)/(230)-88x5% = 230/318=.72327x5%=.03616

IRR = 10%-3.616 or (.3616x100) = 6.384%

IRR/ Cross over Rates of Project x, y = 5% + 88/88- (230) x5%= 88/316 = .27848 x.05=0.01392

IRR = 5% + 1.393 (0.01392x 100) = 6.39%

Summary:

Parameter Projects NPVs Decision Over All Nut Shell- If the cost of
-Cross capital < crossover rate, then NPVY
Over Point < NPVX and IRRY > IRRX. Thus, a
6.38% conflict arises because now the
NPV method will select Project X
while the IRR method will choose Y
Over NPV < Y Select Y- If the cost of capital 12 % >
Point Because NPV Y crossover rate 6.38%, then NPV
curve is above X X $ 967 > NPV $ 633 and IRRX
NPV curve. 18.09% > IRRY 15.015% .
Thus, both methods lead to the
selection of Project X.

Below NPV > Y Select X

Point Because NPV X
curve is above Y
NPV curve.
Crossover Rate Conclusion
 The crossover rate is the cost of capital at which two projects are of equal in terms of
net present values (NPV) or with intersecting NPV profiles.
  The crossover rate formula requires two variables: Initial Investments (for the two
projects) and Cash Flows (from one period to the next).
 The  crossover rate is usually expressed as a percentage.
 The crossover rate is used by companies to know which between two projects is more
favorable.

Sr. # Cause of Conflict NPV Approach IRR Approach

1 Reinvestment rate Cash flows can be Cash flows can be
Assumptions reinvested at the reinvested at IRR.
cost of capital
2. Tenure of Project- Short Run Cash flows are Early cash flows
slowly incoming especially valuable
3