Assignment:
We are using the same numbers that we used for the previous problems. The previous problems file is attached. This time you will compare the projects using the Modified IRR technique. Assume that the reinvestment rate for both projects is 5%.
To get full credit please do the following:
Define the technique.
Discuss the difference between this method and the others we have used so far.
Analyze the numbers in the problem using an excel spreadsheet.
You must use Excel formulas which are on the ribbon in Excel marked Fx to make your calculations whenever possible. Do not write your own formulas unless absolutely necessary.
All information must be in Excel (Word documents will not be read and you will not get credit).
Remember to carry out your answers at least two decimal places.
Please summarize in detail all you have learned during the semester on this project.
INTERNAL RATE OF RETURN METHOD: A metric used in capital budgeting measuring the profitability of potential investments. Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. IRR calculations rely on the same formula as NPV does, and is calculated by setting the NPV to zero to solve for the discount rate r.
"FORMULA: NPV = Σ (Net Period Cash Flow / (1+r)t) - Initial Investment Where (r) is the rate of return, and (t) is the number of time periods. "
|
|
|
|
Project A |
|
Year |
Cash Flow |
|
2014 |
($3,000,000.00) |
|
2015 |
$0.00 |
|
2016 |
$600,000.00 |
|
2017 |
$900,000.00 |
|
2018 |
$2,700,000.00 |
|
|
|
|
IRR: |
10% |
|
|
|
| Project B |
| Year |
Cash Flow |
| 2014 |
($3,000,000.00) |
| 2015 |
$975,000.00 |
| 2016 |
$975,000.00 |
| 2017 |
$975,000.00 |
| 2018 |
$975,000.00 |
| |
|
| IRR: |
11% |
DECISION: The higher a project's internal rate of return, the more desirable it is to undertake the project, so the project with the highest IRR would be considered the best and undertaken first. Therefore, Project B is the more desirable project.
CAPITAL INVESTMENT
PAYBACK PERIOD METHOD - Definition
It's a method of capital investment evaluation that measures the time period an investment will take before the intial investment is recovered.The project with the shortest payback period is selected.
|
PROJECT A |
|
|
|
| year |
|
cashflow |
|
Cumulative cashflow |
time |
| 2014 |
|
$ (3,000,000.00) |
|
|
0 |
| 2015 |
|
$ - |
|
$ - |
1 |
| 2016 |
|
$ 600,000.00 |
|
$ 600,000.00 |
2 |
| 2017 |
|
$ 900,000.00 |
|
$ 1,500,000.00 |
3 |
| 2018 |
|
$ 2,700,000.00 |
|
$ 3,000,000.00 |
3.56 |
|
|
$ 1,200,000.00 |
|
|
|
|
PROJECT B |
|
|
|
| year |
|
cashflow |
|
Cumulative cashflow |
time |
| 2014 |
|
$ (3,000,000.00) |
|
|
0 |
| 2015 |
|
$ 975,000.00 |
|
$ 975,000.00 |
1 |
| 2016 |
|
$ 975,000.00 |
|
$ 1,950,000.00 |
2 |
| 2017 |
|
$ 975,000.00 |
|
$ 2,925,000.00 |
3 |
| 2018 |
|
$ 975,000.00 |
|
$ 3,000,000.00 |
3.08 |
|
|
$ 900,000.00 |
|
|
|
DECISION: If one was to choose on whether to invest in project A or B, It is advisable for the person to choose project B because it has a shorter payback period.