4/11/2010

Chapter 10. Solution for Chapter 10 P23 Build a Model

Gardial Fisheries is considering two mutually exclusive investments. The projects' expected net cash flows are as
follows:

Time
0
1
2
3
4
5
6
7

Expected Net Cash Flows

Project A Project B
($375)
($575)
($300)
$190
($200)
$190
($100)
$190
$600
$190
$600
$190
$926
$190
($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?
@ 12% cost of capital

@ 18% cost of capital

WACC =

WACC =

NPV A =

$226.96

NPV A =

Use Excel's NPV function as explained in this

18% chapter's Tool Kit. Note that the range does not
include the costs, which are added separately.
$18.24

NPV B =

$206.17

NPV B =

$89.54

12%

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.
b. Construct NPV profiles for Projects A and B.
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.

0%
2%
4%
6%
8%
10%
12%
14%
16%
18%

Project A
$226.96
$951.00
$790.31
$648.61
$523.41
$412.58
$314.28
$226.96
$149.27
$80.03
$18.24

Project B
$206.17
$565.00
$489.27
$421.01
$359.29
$303.35
$252.50
$206.17
$163.85
$125.10
$89.54

NPV

NPV Profiles

$1,000.00

$800.00

Project A
$600.00

$400.00

Project B

$200.00

$0.00
-5%
($200.00)

0%

5%

10%

15%

20%

25%

Cost of Capital

30%

$600.00

$400.00

$200.00

20%
22%
24%
26%
28%
30%

($36.98)
($86.39)
($130.65)
($170.34)
($205.97)
($237.98)

$56.85
$26.71
($1.11)
($26.85)
($50.72)
($72.88)

$0.00
-5%

0%

5%

10%

15%

($200.00)

20%

25%

30%

Cost of Capital

($400.00)

c. What is each project's IRR?

We find the internal rate of return with Excel's IRR function:

IRR A =
IRR B =

18.64% Note in the graph above that the X-axis intercepts are equal to the two projects' IRRs.
23.92%

d. What is the crossover rate, and what is its significance?

Time
0
1
2
3
4
5
6
7

Cash flow
differential
$200
($490)
($390)
($290)
$410
$410
$736
($200)

Crossover rate =

13.14%

The crossover rate represents the cost of capital at which the two projects
have the same net present value. In this scenario, that common net present
value, at a cost of capital of 13.14% is:
$182

e. What is each project's MIRR at a cost of capital of 12%? At r = 18%? (Hint: Consider Period 7 as the end of
Project B's life.)
@ 12% cost of capital

@ 18% cost of capital

MIRR A =
MIRR B =

MIRR A =
MIRR B =

15.43%
17.01%

18.34%
20.47%

f. What is the regular payback period for these two projects?

Project A
Time period
Cash flow
Cumulative cash flow
Payback

0
(375)
(375)
4.625

1
(300)
(675)

2
(200)
(875)

3
(100)
(975)

4
600
(375)

5
$600
225

6
$926
1,151

7
($200)
951

0
(575)
(575)
3.026

1
190
(385)

2
190
(195)

3
190
(5)

4
190
185

5
$190
375

6
$190
565

7
$0
565

Project B
Time period
Cash flow
Cumulative cash flow
Payback

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

WACC =

12%

Project A
Time period
Cash flow
Disc. cash flow
Disc. cum. cash flow
Discounted Payback

0
(375)
(375)
(375)
5.40

1
(300)
(268)
(643)

2
(200)
(159)
(802)

3
(100)
(71)
(873)

4
600
381
(492)

5
$600
340
(152)

6
$926
469
317

7
($200)
(90)
227

0
(575)
(575)
(575)
3.98

1
190
170
(405)

2
190
151
(254)

3
190
135
(119)

4
190
121
2

5
$190
108
110

6
$190
96
206

7
$0
0
206

Project B
Time period
Cash flow
Disc. cash flow
Disc. cum. cash flow
Discounted Payback

h. What is the profitability index for each project if the cost of capital is 12%?
PV of future cash flows for A:
PI of A:

$601.96
1.61

PV of future cash flows for B:

PI of B:

$781.17
1.36

end of