Case Report: The Investment Detective

Year

Project 1

Project

Project

Project

Project

Project

Project

Project 8

Initial

-2,000

2
-2,000

3
-2,000

4
-2,000

5
-2,000

6
-2,000

7
-2,000

-2,000

280
280
280
280
280
280
280
280*
280
280
280
280
280
280
280

2,200*

1,200
900*
300
90
70

-350
-60
60
350
700
1,200
2,250*

10,000*

160
200
350
395
432
440*
442
444
446
448
450
451
451
452
-2,000

investment
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Sum of
cash flows

330
330
330
330
330
330
330*
1,000

1,666
334*
165

3,310

2,165

10,000

3,561

4,200

2,200

2,560

4,150

1,310

165

8,000

1,561

2,200

200

560

2,150

benefits
Excess of
cash flow
over initial
investment

1. We could blindly rank the projects by simple inspection of the cash flow, which are
by looking at the pay back period time and excess of cash flow.

Ranking by looking at the excess of cash flow, the preferable investment would be
project 3 and by payback period, the preferable investment would be project 6.
However, by using these methods we simply neglecting the time values of money
and the companies cost of capital. We use capital budgeting tools to measure
financial performance of projects. The major available tools are NPV, IRR, PI and
others. By using these tools we can conclude whether sum of the cash flows of a
project exceeds expected return rate or cost of capital of a company or not.

2. Criteria that might be used to rank the projects are NPV, PI, IRR and MIRR. We
were still in doubt which method is the best because the theoretical and practical
strengths of the approaches differ. We would use both NPV and IRR as the best
method looking from the theoretical and practical view.
One of the reason why we still in doubt which one is the better method because of
mutually exclusive between project 7 and 8. For project 7 and 8 that mutually
exclusive, the company could have some difficulties deciding depend on the cost of
capital and NPV, as in figure below
Project 7&8
$3,000.00
$2,000.00
$1,000.00
$0.00
-$1,000.00
-$2,000.00

Project 7

Project 8

The IRR of project 7 is greater than the IRR of project 8, so managers using the
IRR method to rank projects will always choose 7 over 8

The NPV of project 7 is sometimes higher and sometimes lower than the NPV of
project 8; thus, the NPV method will not consistently rank project 7 above project
8 or vice versa. The NPV ranking will depend on the firms cost of capital.

When the cost of capital is approximately 10%, projects 7 & 8 have identical
NPVs.

3. Ranking by quantitative methods

The rank using quantitative methods differ from the ranking by simple inspection of
cash flow. This is happened because the ranking using quantitative methods take
value of money and discount rate into account. By using quantitative methods, we
recommend the company to invest on project 3, 4, 7 and 8.
4. Real investment projects that have similar cash flow:
Project 1 Leasing or Partially Amortizing Bond
Project 2 Advertising campaign
Project 3 Zero-Coupon Bond
Project 4 Nuclear-power plant
Project 5 Leasing with 0 terminal value or Home mortgage
Project 6 One-year bond
Project 7 Mine
Project 8 Orchard