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 SIMSOXâ€™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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