Connor Corporation is considering two projects (see below). For your analysis, assume these projects are mutually exclusive with a required rate of return of 12%. Project 1 Project 2 Initial investment $(510,000) $(685,000) Cash inflow Year 1 $485,000 $610,000 Compute the following for each project: NPV (net present value) PI (profitability index) IRR (internal rate of return) (The answers have already been computed below for you to answer the following questions) Based on your analysis, answer the following questions Which is the best choice? Why? Which project should be selected and why? If the projects had the same IRR amounts but different NPV totals, then how would you know which project to select? Explain. What would happen if both projects had negative NPV totals? Which project would you choose? What do negative NPVs indicate? Explain. Should we also use the payback method to assist us in project selection? Why or why not? Explain check_circle Expert Answer thumb_up thumb_down Step 1 Net present value is the excess of the present value of cash inflows over the present value of cash outflows. The projects having positive net present value are profitable for the company and they provide value addition. Note: Since we only answer up to 3 sub-parts, we’ll answer the first 3. Please resubmit the question and specify the other subparts (up to 3) you’d like answered Step 2 Compute the net present value for project 1, using the equation as shown below: Net present value====Year 1 cash flow1+Rate−Initial investment$485,0001+0.12−$510,000$433,035.71−$510,000($76,964.29)Net present value=Year 1 cash flow1+Rate-Initial investment=$485,0001+0.12-$510,000=$433,035.71-$510,000=$76,964.29 Hence, the net present value for project 1 is ($76,964.29). Step 3 Compute the net present value for project 2, using the equation as shown below: Net present value====Year 1 cash flow1+Rate−Initial investment$610,0001+0.12−$685,000$544,642.86−$685,000($140,357.14)Net present value=Year 1 cash flow1+Rate-Initial investment=$610,0001+0.12-$685,000=$544,642.86-$685,000=$140,357.14 Hence, the net present value for project 2 is ($140,357.14). Step 4 Compute the profitability index for project 1, using the equation as shown below: PI===Present value of inflowInitial investment$433,035.71$510,0000.85PI=Present value of inflowInitial investment=$433,035.71$510,000=0.85 Hence, the profitability index for project 1 is 0.85. Step 5 Compute the profitability index for project 2, using the equation as shown below: PI===Present value of inflowInitial investment$544,642.86$685,0000.80PI=Present value of inflowInitial investment=$544,642.86$685,000=0.80 Hence, the profitability index for project 2 is 0.80. Step 6 Compute the internal rate of return (IRR) for project 1, using the equation as shown below: IRR====Year 1 cash flowInitial investment−1$485,000$510,000−10.95−10.05IRR=Year 1 cash flowInitial investment-1=$485,000$510,000-1=0.95-1=0.05 Hence, the internal rate of return for project 1 is 0.05. Step 7 Compute the internal rate of return (IRR) for project 2, using the equation as shown below: IRR====Year 1 cash flowInitial investment−1$610,000$685,000−10.89−10.11IRR=Year 1 cash flowInitial investment-1=$610,000$685,000-1=0.89-1=0.11 Hence, the internal rate of return for project 2 is 0.11. Step 8 Answer: The net present value for project 1 is ($76,964.29). The net present value for project 2 is ($140,357.14). The profitability index for project 2 is 0.85. The profitability index for project 2 is 0.80. The internal rate of return for project 2 is 0.05. The internal rate of return for project 2 is 0.11.
- Connor Corporation is considering two projects (see below). For your analysis, assume these projects are mutually exclusive with a required
rate of return of 12%.
|
|
Project 1 |
Project 2 |
|
Initial investment |
$(510,000) |
$(685,000) |
|
|
$485,000 |
$610,000 |
Compute the following for each project:
- NPV (
net present value ) - PI (profitability index)
- IRR (
internal rate of return )
(The answers have already been computed below for you to answer the following questions)
Based on your analysis, answer the following questions
- Which is the best choice? Why?
- Which project should be selected and why? If the projects had the same IRR amounts but different NPV totals, then how would you know which project to select? Explain.
- What would happen if both projects had negative NPV totals? Which project would you choose? What do negative NPVs indicate? Explain.
- Should we also use the payback method to assist us in project selection? Why or why not? Explain
Expert Answer
Net present value is the excess of the present value of cash inflows over the present value of
Note: Since we only answer up to 3 sub-parts, we’ll answer the first 3. Please resubmit the question and specify the other subparts (up to 3) you’d like answered
Compute the net present value for project 1, using the equation as shown below:
Net present value====Year 1 cash flow1+Rate−Initial investment$485,0001+0.12−$510,000$433,035.71−$510,000($76,964.29)Net present value=Year 1 cash flow1+Rate-Initial investment=$485,0001+0.12-$510,000=$433,035.71-$510,000=$76,964.29
Hence, the net present value for project 1 is ($76,964.29).
Compute the net present value for project 2, using the equation as shown below:
Net present value====Year 1 cash flow1+Rate−Initial investment$610,0001+0.12−$685,000$544,642.86−$685,000($140,357.14)Net present value=Year 1 cash flow1+Rate-Initial investment=$610,0001+0.12-$685,000=$544,642.86-$685,000=$140,357.14
Hence, the net present value for project 2 is ($140,357.14).
Compute the profitability index for project 1, using the equation as shown below:
PI===Present value of inflowInitial investment$433,035.71$510,0000.85PI=Present value of inflowInitial investment=$433,035.71$510,000=0.85
Hence, the profitability index for project 1 is 0.85.
Compute the profitability index for project 2, using the equation as shown below:
PI===Present value of inflowInitial investment$544,642.86$685,0000.80PI=Present value of inflowInitial investment=$544,642.86$685,000=0.80
Hence, the profitability index for project 2 is 0.80.
Compute the internal rate of return (IRR) for project 1, using the equation as shown below:
IRR====Year 1 cash flowInitial investment−1$485,000$510,000−10.95−10.05IRR=Year 1 cash flowInitial investment-1=$485,000$510,000-1=0.95-1=0.05
Hence, the internal rate of return for project 1 is 0.05.
Compute the internal rate of return (IRR) for project 2, using the equation as shown below:
IRR====Year 1 cash flowInitial investment−1$610,000$685,000−10.89−10.11IRR=Year 1 cash flowInitial investment-1=$610,000$685,000-1=0.89-1=0.11
Hence, the internal rate of return for project 2 is 0.11.
Answer:
The net present value for project 1 is ($76,964.29).
The net present value for project 2 is ($140,357.14).
The profitability index for project 2 is 0.85.
The profitability index for project 2 is 0.80.
The internal rate of return for project 2 is 0.05.
The internal rate of return for project 2 is 0.11.
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