Suppose you are a capital budgeting analyst for a company considering investments in six projects listed in Exhibit 1. The company has determined that they can undertake each of these projects and have forecasted the project cash flows from each project in Exhibit 1.
The chief financial officer of your company has asked you to rank the projects and recommend the "three best" that the company should accept. You will rank the projects based on quantitative decisions alone. No other project characteristics are relevant in the selection, except that management has determined that projects 3 and 4 are mutually exclusive. All other projects are independent.
All the projects require the same initial investment, $5 million. Moreover, all are believed to be of the same risk class. Assume that 12% is an appropriate discount rate (some officers of the company have suggested that the discount rate should be higher).
Calculate: NPV, IRR, MIRR, profitability index.
Calculate the crossover point for Projects #3 and #4. This is the point at which the NPVs of the two projects are the same. Looking at this discount rate and at the discount rate given in the case, how might this influence your decision about which project to accept?
Exhibit 1
Project Cash Flows (dollars in thousands)
Project: 1, 2, 3, 4, 5, 6
Initial cost: -5000, -5000, -5000, -5000, -5000, -5000
Year
1: 0, 700, 2500, -550, 670, 625
2: 0, 900, 1700, -50, 670, 625
3: 0, 915, 900, 60, 670, 625
4: 0, 920, 700, 450, 670, 625
5: 0, 925, 500, 800, 670, 625
6: 0, 930, 300, 1100, 670, 625
7: 0, 940, 200, 1350, 670, 625
8: 0, 950, 150, 1500, 670, 625
9: 0, 960, 100, 1625, 670, 625
10: 0, 970, 60, 1725, 670, 625
11: 0, 980, 30, 1810, 670, 625
12: 0, 990, 20, 1885, 670, 625
13: 0, 1000, 10, 1935, 670, 625
14: 0, 1100, 5, 1975, 670, 625
15: 22000, -5000, 5, 2000, 670, 5625