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Project Number 1 2 3 4
Initial Investment($) -2000 -2000 -2000 -2000
Year1 330 1666 0 160
Year2 330 334 0 200
Year3 330 165 0 350
Year4 330 0 395
Year5 330 0 432
Year6 330 0 440
Year7 330 0 442
Year8 1000 0 444
Year9 0 446
Year10 0 448
Year11 0 450
Year12 0 451
Year13 0 451
Year14 0 452
Year15 10000 -2000
Calculations
Payback Period (Y) 6.06 2 14.2 6.05
IRR 10.87% 6.31% 11.33% 12.33%
-15.22%
NPV with DF=8% $258.37 ($40.07) $1,152.42 $448.82
NPV with DF=10% $73.09 ($85.45) $393.92 $228.22
NPV with DF=12% ($90.08) ($128.79) ($173.04) $30.41
sh Flows
5 6 7 8
-2000 -2000 -2000 -2000
280 2200 1200 -350
280 900 -60
280 300 60
280 90 350
280 70 700
280 1200
280 2250
280
280
280
280
280
280
280
280
s
7.14 0.9 1.89 6.04
11.12% 10.00% 15.26% 11.41%
Explaination
From the above calculation we can see Project 6 has the lowest payback period an
this does not provide much insight into which investment project should be taken
drawbacks of not considering the time value of money and the later cash flows aft
recovered. Only if the Company is in dire need for money should they implememe
projects with low short term payback, ie take up Project 6 even though it has the
investment, and not give a thought about Project 3 even though it has the highest
Project 2 and 7
Front-loaded cash flow
ack period. Based
.
e lowest payback period and Project 3 the highest payback period. But
nt project should be taken up since the payback rule has several
and the later cash flows after the initial investment seems to have been
ey should they implemement this evaluation tool for picking profitable
t 6 even though it has the 2nd lowest excess of cash flow over initial
n though it has the highest excess of cash flow over initial investment.
For each set of project cash flows, calculate the Internal Rate of Return (IRR). Bas
these criteria, rank the projects.
Explaination
Case 1 Case 2
Ranks Project # IRR Values Ranks
I 7 15.26% I
II 4 12.33% II
III 8 11.41% III
IV 3 11.33% IV
V 5 11.12% V
VI 1 10.89% VI
VII 6 10.00% VII
VIII 2 6.31% VIII
1. Upon Calculating the IRRs of different projects, we can alot different ranks to pr
2. In Exhibit 1, all projects except project 4 have a conventional cash flows and th
in ranking of the projects.
3. The IRRs of project 4 are 12.33% and -15.22%. In the case where the IRR is ta
above.
4. It is better to consider the NPV value for project 4 in order to determine whethe
determined from.
5. Changes in the ranks and the cause of 2 cases is due to the non-conventional c
Project Numbe 1 2 3 4
Initial Invest -2000 -2000 -2000 -2000
Year1 330 1666 0 160
Year2 330 334 0 200
Year3 330 165 0 350
Year4 330 0 395
Year5 330 0 432
Year6 330 0 440
Year7 330 0 442
Year8 1000 0 444
Year9 0 446
Year10 0 448
Year11 0 450
Year12 0 451
Year13 0 451
Year14 0 452
Year15 10000 -2000
IRR 1 2 3 4
-0.16 $6,961.16 $735.07 $134,713.28 ($948.13)
-0.14 $5,759.71 $648.22 $94,055.72 $1,093.25
-0.12 $4,759.65 $566.61 $66,039.31 $2,114.44
-0.1 $3,922.54 $489.79 $46,569.36 $2,525.04
-0.08 $3,217.99 $417.38 $32,928.71 $2,578.28
-0.06 $2,621.91 $348.99 $23,297.77 $2,430.28
-0.04 $2,115.02 $284.33 $16,447.24 $2,176.72
-0.02 $1,681.88 $223.08 $11,539.69 $1,875.50
0 $1,310.00 $165.00 $8,000.00 $1,561.00
0.02 $989.25 $109.85 $5,430.15 $1,252.95
0.04 $711.37 $57.41 $3,552.65 $962.03
0.06 $469.60 $7.49 $2,172.65 $693.38
0.08 $258.37 ($40.07) $1,152.42 $448.82
0.1 $73.09 ($85.45) $393.92 $228.22
0.12 ($90.08) ($128.79) ($173.04) $30.41
0.14 ($234.30) ($170.22) ($599.04) ($146.34)
0.16 ($362.25) ($209.87) ($920.73) ($303.97)
0.18 ($476.16) ($247.84) ($1,164.84) ($444.46)
0.2 ($577.92) ($284.24) ($1,350.95) ($569.68)
0.22 ($669.12) ($319.16) ($1,493.47) ($681.38)
0.24 ($751.13) ($352.69) ($1,603.11) ($781.14)
0.26 ($825.09) ($384.91) ($1,687.79) ($870.40)
0.28 ($892.01) ($415.90) ($1,753.48) ($950.41)
0.3 ($952.71) ($445.73) ($1,804.63) ($1,022.27)
0.32 ($1,007.94) ($474.45) ($1,844.62) ($1,086.97)
0.34 ($1,058.33) ($502.13) ($1,876.00) ($1,145.34)
0.36 ($1,104.41) ($528.83) ($1,900.71) ($1,198.13)
Rate of Return (IRR). Based upon IRR for Project 4 and Pro
jects.
$12,000.00
$10,000.00
$8,000.00
Case 2
Project # IRR Values $6,000.00
NPV
7 15.26%
$4,000.00
8 11.41%
3 11.33%
$2,000.00
5 11.12%
1 10.89% $0.00
6 10.00% -0.16 -0.14 -0.12 -0.1 -0.08 -0.06 -0.04 -0.02 0 0.02
2 6.31% ($2,000.00)
4 -15.22%
Cost of Capital
n alot different ranks to projects. The project with the highest IRR is ranked first and the project with
entional cash flows and thus have a single IRR. Project 4 has a non-conventional cash flow and thereb
e case where the IRR is taken as 12.33%, it is ranked second and when the IRR is taken as -15.22%,
order to determine whether the project should be picked by the company to invest in as a better meas
5 6 7 8
-2000 -2000 -2000 -2000
280 2200 1200 -350
280 900 -60
280 300 60
280 90 350
280 70 700
280 1200
280 2250
280
280
280
280
280
280
280
280
5 6 7 8
$20,174.82 $619.05 $1,558.39 $11,017.00
$15,211.14 $558.14 $1,397.21 $9,167.07
$11,542.51 $500.00 $1,248.77 $7,612.44
$8,799.42 $444.44 $1,111.69 $6,300.46
$6,725.05 $391.30 $984.78 $5,188.78
$5,138.96 $340.43 $867.00 $4,243.21
$3,913.07 $291.67 $757.46 $3,435.98
$2,955.57 $244.90 $655.36 $2,744.43
$2,200.00 $200.00 $560.00 $2,150.00
$1,597.79 $156.86 $470.77 $1,637.42
$1,113.15 $115.38 $387.11 $1,194.05
$719.43 $75.47 $308.55 $809.43
$396.65 $37.04 $234.66 $474.84
$129.70 $0.00 $165.04 $182.98
($92.96) ($35.71) $99.35 ($72.25)
($280.19) ($70.18) $37.29 ($296.01)
($438.87) ($103.45) ($21.44) ($492.65)
($574.36) ($135.59) ($77.08) ($665.83)
($690.87) ($166.67) ($129.85) ($818.70)
($791.74) ($196.72) ($179.98) ($953.91)
($879.64) ($225.81) ($227.64) ($1,073.74)
($956.70) ($253.97) ($273.00) ($1,180.15)
($1,024.65) ($281.25) ($316.23) ($1,274.81)
($1,084.90) ($307.69) ($357.46) ($1,359.16)
($1,138.60) ($333.33) ($396.83) ($1,434.46)
($1,186.68) ($358.21) ($434.45) ($1,501.78)
($1,229.94) ($382.35) ($470.44) ($1,562.07)
RR for Project 4 and Project 8
4
8
-0.06 -0.04 -0.02 0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16
Cost of Capital
.
For each set of project cash flows, calculate the Net Present Value, using discoun
12%, respectively. For each discount rate, rank the projects. Explain why the r
discount rate increases.
Explaination
Cost of Capital=8%
$1,400.00
$1,200.00
$1,000.00
$800.00
$600.00
NPV
$400.00
$200.00
$0.00
Project 1
Project 2
Project 4
Project 5
Project 7
Project 8
Project 3
Project 6
($200.00)
Cost of Capital=12
$150.00
$100.00
$50.00
$0.00
Project 1
Project 2
Project 3
Project 4
NPV
($50.00)
($100.00)
($150.00)
($200.00)
($50.00)
Pr
Pr
Pr
Pr
($100.00)
($150.00)
($200.00)
1. In the case where the cost of capital is 8%, all projects except project 2 has a p
2. In the case where the cost of capital is 10%, we can select all projects except fo
the case of project 6, we are indifferent to the project acceptance as the NPV is eq
period in order to get a better understanding of whether to accept or reject projec
3. In the case where the cost of capital is 12%, only project 4 and project 7 have
should be rejected because of their negative NPVs.
4. Since the term of the projects are different, the influences by the discount rate
5. Some long-term projects will be more risky when the discount rate grows. And
6. Project 3 is more volatile and sensitive to discount rate since it gets paid once a
nt Value, using discount rates of 8%, 10%, and Project 1
ects. Explain why the ranking changes as the 8% $258.37
eases. 10% $73.09
12% ($90.08)
Discount Rate=12%
Project # NPV
7 $99.35
4 $30.41
6 ($35.71)
8 ($72.25)
1 ($90.08)
5 ($92.96)
2 ($128.79)
3 ($173.04)
Cost of Capital=10%
$500.00
$400.00
$300.00
$200.00
NPV
$100.00
$0.00
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Project 7
Project 8
($100.00)
Project 7
Project 8
($200.00)
Cost of Capital=12%
Project 2
Project 3
Project 4
Project 5
Project 6
Project 7
Project 8
Pr
Pr
Pr
Pr
Pr
Pr
Pr
xcept project 2 has a positive NPV, which is why we accept all projects except project 2.
ct all projects except for project 2 and project 6 on the basis of the positive NPV value. In
tance as the NPV is equal to zero. We should consider other criteria like IRR and payback
accept or reject project 6.
4 and project 7 have a positive NPV, and therefore should be accepted. All other projects
How would you rank them based on NPV? Based on IRR? Are your rankings the
same? If not, explain why.
Explaination
$2,500.00
Project 7 Project 8 $2,000.00
Initial Investment($) -2000 -2000
$1,500.00
Year1 1200 -350
Year2 900 -60 $1,000.00
Year3 300 60 $500.00
NPV
Year4 90 350
$0.00
Year5 70 700 0.00
Year6 1200 ($500.00)
Year7 2250 ($1,000.00)
($1,500.00)
NPV at 10% $165.04 $182.98
Payback Period 1.89 6.04 ($2,000.00)
IRR 15.26% 11.41%
1. Based on NPV, Project 8 is ranked first but according to the IRR rule, Project 7
flow patterns and the length of the projects.
2. Though the IRR of project 7 is higher than that of project 8, it is not a very goo
recognize the distinction between positive and negative cash flows.
3. Inspite of having negative cash flows for the first two years in project 8, it is sti
the company.Also, long-term investments are more sensitive to change in discoun
4. Hence, a decrease in cost of capital to 8%, increases the NPV of both projects.
However, with an increase in the discount rate to 12%, the outflows grow and the
fact of IRR being lower than the cost of capital.
5. So, project 7 should be accepted and not project 8.
Thus, if two mutually exclusive projects show positive NPVs and the IRR in both pr
This is using the assumption that the company is not financially constrained.
5. So, project 7 should be accepted and not project 8.
Thus, if two mutually exclusive projects show positive NPVs and the IRR in both pr
This is using the assumption that the company is not financially constrained.
$2,000.00
$1,500.00
$1,000.00
$500.00
NPV
$0.00
0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16 0.18 0.20 0.22 0.24 0.26 0.28 0.30 0.32 0.34 0.36
($500.00)
($1,000.00)
($1,500.00)
($2,000.00)
Cost of Capital
Project 7 Project 8
RR rule, Project 7 is preferable. Both the NPV and IRR display conflicting results due to the difference i
t is not a very good criterion for the acceptance or rejection of a proposal, since in this case, IRR does
ws.
n project 8, it is still chosen over project 7, due to greater NPV as it leads to an increase in the overall
change in discount rates.
of both projects. But the decision remains the same as in situation above, due to higher NPV for proje
ows grow and the inflows decrease, thus leading to negative NPV in project 8. This is also accompanie
the IRR in both projects is greater than the cost of capital, the NPV rule prevails.
constrained.
the IRR in both projects is greater than the cost of capital, the NPV rule prevails.
constrained.
s.
s.
In addition to NPV and IRR, are there any other consideration that might affect y
choice of the project?
Explanation
In addition to NPV and IRR, following criteria could be used for determining the pr
1. Discount Rate (Since it’s related to NPV and we should reject projects whose IR
capital).
(2*. Payback Period - In this case, there is no influence on the choice of project si
higher cash flow at each time point than Project 7.)
3. Profitability Index - Profitability index is another criterion we could use to determ
Profitability index can be given by the present values of future cash flows divided b
can assist in ranking the projects and help determine the choice of project to be a
project with a positive NPV will have PI > 1.
4. Initial investment. If the initial investment of project 7 and 8 is different, we sh
consideration besides IRR and NPV.
Project 7
Year CF PV Factor Disc. CF
1 $1,200.00 $0.91 $1,090.91
2 $900.00 $0.83 $743.80
3 $300.00 $0.75 $225.39
4 $90.00 $0.68 $61.47
5 $70.00 $0.62 $43.46
6
7
Discounted Payback Period
mutually exclusive and the cost of
ion only for project #7 and #8.
t7 Project 8
Cum. Disc CF CF PV Factor Disc. CF Cum. Disc CF
$1,090.91 ($350.00) $0.91 ($318.18) ($318.18)
$1,834.71 ($60.00) $0.83 ($49.59) ($367.77)
$2,060.11 $60.00 $0.75 $45.08 ($322.69)
$2,121.58 $350.00 $0.68 $239.05 ($83.63)
$2,165.04 $700.00 $0.62 $434.64 $351.01
$1,200.00 $0.56 $677.37 $1,028.38
$2,250.00 $0.51 $1,154.61 $2,182.98
2.73 Discounted Payback Period 6.84