You are a financial analyst for the Waffle Company. The director of capital budgeting has asked you to analyze two proposed capital investments, Projects A and B. Each project has a cost of $50,000, and the cost of capital for each is 10%.
The projects’ expected net cash flows are as follows:
|Expected Net Cash Flows|
|Year||Project A||Project B|
- Calculate each project’s payback period, net present value (NPV), internal rate of return (IRR), modified internal rate of return (MIRR), and profitability index (PI).
- Which project will you select if your decision was based solely on the project’s payback period?
- Which project or projects should be accepted if they are independent?
- Which project should be accepted if they are mutually exclusive?
- d. How might a change in the cost of capital produce a conflict between the NPV and IRR rankings of these two projects? Would this conflict exist if r were 6%? (Hint: Plot the NPV profiles.)
Marvin Industries must choose between an electric-powered and a coal-powered forklift machine for its factory. Because both machines perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered machine will cost more, but it will be less expensive to operate; it will cost $102,000, whereas the coal-powered machine will cost $69,500. The cost of capital that applies to both investments is 10%. The life for both types of machines is estimated to be 6 years, during which time the net cash flows for the electric-powered machine will be $26,150 per year, and those for the coal-powered machine will be $20,000 per year. Annual net cash flows include depreciation expenses.
- Calculate the NPV and IRR for each type of machine, and decide which to recommend.