Consider the following projects, A and B where the firm can only choose one. Project A costs $30 and has cash flows of $5, 10, 15, 20 in each of the next four years. Project B also costs $30, and generates cash flows of $20, 10, 8, 6 for the next four years, respectively. WACC is 10 percent.
- A) Draw the timelines for both projects: A and B.
- B) Calculate the projects’ NPVs, IRRs, payback periods.
- C) If the two projects are independent, which project(s) should be chosen?
- D) If the two projects are mutually exclusive, which projects should be chosen?
- E) Plot NPV profiles for the two projects ( using Excel). Identify the projects’ IRRs on the graph.
- F) If the WACC were 5 percent, would this change your recommendation if the projects were mutually exclusive? If the WACC were 15 percent, would this change your recommendation? Explain your answers.
- G) There is a “crossover rate” of A’s and B’s NPV curves, and mark it on the graph with Point O (Hint: 13.53%). Explain in words what this rate is and how it affects the choice between mutually exclusive projects.
- H) If it possible for conflicts to exist between the NPV and the IRR when independent projects are being evaluated? Explain your answer.
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