You are the head of the project selection team at SIMSOX.* Your team is considering three…
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Question “You are the head of the project selection team at SIMSOX.* Your team is considering three…”
You are the head of the project selection team at SIMSOX.* Your
team is considering three different projects. Based on past
history, SIMSOX expects at least a rate of return of 20 percent.
Given the following information for each project, which one should
be SIMSOX’s first priority? Should SIMSOX fund any of the other
projects? If so, what should be the order of priority based on
return on investment? (See chart below)
Answer
Answer
- Voyagers is the first priority project #3. It has an internal rate of return of 44 percent, which covers the capital cost (20%).
- Additionally, it has the highest IRR and NPV compared to the other 2 projects. Therefore, it should be pursued.
- SIMSOX should avoid investing in other projects (#1 & #2), as they have negative NPVs and are not expected to achieve IRR.
Refer to the calculations below.
Project 1 | |||||
Cost of capital | 20% | ||||
Year | 0 | 1 | 2 | 3 | |
Net cash flow | (500,000) | 50,000 | 250,000 | 350,000 | |
PV factor | 100% | 83% | 69% | 58% | =B10/(1+$B$4) |
PV of net cash flow | (500,000) | 41,667 | 173,611 | 202,546 | =C9*C10 |
Cumulative PV | (500,000) | (458,333) | (284,722) |
(82,176) | =B12+C11 |
Net present value |
(82,176) | =NPV(B4,C9:E9)+B9 | |||
IRR (Internal Rate of Return) | 11% | =IRR(B9:E9,0.1) |
Project 2 | |||||
Cost of capital | 20% | ||||
Year | 0 | 1 | 2 | 3 | 4 |
Net cash flow | (250,000) | 75,000 | 75,000 | 75,000 |
50,000 |
PV factor | 100% | 83% | 69% | 58% | 48% |
PV of net cash flow | (250,000) | 62,500 | 52,083 | 43,403 |
24,113 |
Cumulative PV | (250,000) | (187,500) | (135,417) |
(92,014) |
(67,901) |
Net present value |
(67,901) | ||||
IRR (Internal Rate of Return) | 4% |
Project 3 | ||||||
Cost of capital | 20% | |||||
Year | 0 | 1 | 2 | 3 | 4 | 5 |
Net cash flow | (75,000) | 15,000 | 25,000 | 50,000 |
50,000 | 150,000 |
PV factor | 100% | 83% | 69% | 58% | 48% | 40% |
PV of net cash flow | (75,000) | 12,500 | 17,361 | 28,935 |
24,113 | 60,282 |
Cumulative PV | (75,000) | (62,500) |
(45,139) |
(16,204) |
7,909 |
68,191 |
Net present value | Net cash flow1 | |||||
IRR (Internal Rate of Return) | Net cash flow3 |
Excel
Net cash flow4
Conclusion
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