West Coast Chemical Company (WCCC) is considering two mutually exclusive investments. The projects’ expected net cash flows are as follows:
Expected Net Cash Flows
Year Project A Project B
0 $(45,000) $(50,000)
1 20,000 15,000
2 11,000 15,000
3 20,000 15,000
4 30,000 15,000
5 45,000 15,000
Using Excel
a. Construct NPV profiles for Projects A and B.
b. Calculate each project’s IRR.
c. If the required rate of return for each project is 13 percent, which project should West Coast select? If the required rate of return is 9 percent, what would be the proper choice? If the required rate of return is 15 percent, what would be the proper choice?
d. At what rate do the NPV profiles of the two projects cross?
e. Project A has a large cash flow in Year 5 associated with ending the project. WCCC’s management is confident of Project A’s cash flows in Years 0 to 4 but is uncertain about what its Year 5 cash flow will be. (There is no uncertainty about Project B’s cash flows.) Under a worst-case scenario, Project A’s Year 5 cash flow will be $40,000, whereas under a best-case scenario, the cash flow will be $50,000. Redo parts (a), (b), and (d) for each scenario, assuming a 13 percent required rate of return. Assuming a required rate of return for each project is 13 percent, which project should be selected under each scenario?