Himalayan Trading House is considering two mutually exclusive investments. The projects expected net cash flows (in million) are as follows: Year 0 1 2 Project A (Rs) (300) (387) (193) (100) 6 3 4 500 850 500 7 100 Problem 3.23. NPV, IRR and PI 134 134 134 134 134 134 0 a. Construct NPV profile of each project. b. What is each project's IRR? c. If you were told that each project's required rate of return was 12 percent, which project should be selected? If the required rate of return was 15 percent, what would the proper choice be? d. Why does conflict exist in project ranking between NPV and IRR method?
Question
Himalayan Trading House is considering two mutually exclusive investments. The projects expected net cash flows (in million) are as follows: Year 0 1 2 Project A (Rs) (300) (387) (193) (100) 6 3 4 500 850 500 7 100 Problem 3.23. NPV, IRR and PI 134 134 134 134 134 134 0 a. Construct NPV profile of each project. b. What is each project's IRR? c. If you were told that each project's required rate of return was 12 percent, which project should be selected? If the required rate of return was 15 percent, what would the proper choice be? d. Why does conflict exist in project ranking between NPV and IRR method?
Solution
The information provided seems to be incomplete. The cash flows for Project A and Project B are not clearly stated. However, I can explain how to approach these problems.
a. To construct the NPV (Net Present Value) profile of each project, you need to calculate the NPV for different discount rates (including 0%). The NPV is calculated as follows:
NPV = ∑ [Rt / (1+i)^t] - C0
Where: Rt = net cash inflow during the period t i = discount rate or rate of return t = number of time periods C0 = initial investment
b. To calculate the IRR (Internal Rate of Return), you need to set the NPV equation to zero and solve for i. This can be complex with more than one cash flow and may require the use of software or a financial calculator.
c. If the required rate of return is given, you can calculate the NPV for each project at this rate. The project with the higher NPV should be selected. If the NPV is negative, the project should not be undertaken.
d. Conflict in project ranking between NPV and IRR method can occur due to several reasons:
- Different project sizes: IRR doesn't take into consideration the size of the project, while NPV does. A larger project may have a lower IRR but a higher NPV, leading to a conflict.
- Different cash flow patterns: If the projects have different cash flow patterns (e.g., one has earlier cash flows while the other has later cash flows), the IRR method may give different rankings than the NPV method.
- Reinvestment assumption: IRR assumes that the cash flows are reinvested at the IRR itself, while NPV assumes that the cash flows are reinvested at the discount rate. This can lead to different rankings if the IRR and the discount rate are different.
Please provide the complete cash flow information for both projects so that I can help you calculate the NPV, IRR, and make a proper choice based on the required rate of return.
Similar Questions
There are two projects: project A and project B. Each of the project has the cost of Rs 100,000 and cost of capital for each project is 12 percent. The project's expected net cash flows are as follows: Year Project A Project B 0 Rs (100,000) Rs (100,000) 1 65,000 35,000 2 30,000 30,000 3 30,000 30,000 4 10,000 10,000 a. Calculate NPV for each project. Which project or projects should be accepted if they are independent? b. Calculate IRR for each project. Which project should be accepted if they are mutually exclusive?
Annapurna Trading Ltd. is evaluating two mutually exclusive projects: Project A and Project B. The company will require Rs 100,000 for Project A and Rs 140,000 for Project B. The net cash flows of these projects are as follows: Ans: a. (Rs 3,027,947); (Rs 2,168,414); b. cannot be calculated Year Cash Flows A B Rs 100,000 -Rs 140,000 Profit after taxes 1 Rs 10,000 Rs 25,000 2 15,000 25,000 3 20,000 25,000 4 25,000 25,000 5 35,000 25,000 Both projects will be depreciated on straight line over a five-year life and cost of capital of the company is 12 percent. a. Calculate the PBP of each project. If firm has set a maximum payback period of three years, suggest as to which project is preferred. b. Evaluate the projects on the basis of their NPV. c. What are the profitability indexes of both projects?
IRRA company is looking for an opportunity to invest ₹1,500 crore, for which it has identified five independent projects. The cash flows and the initial investment requirement of these five projects are as follows (in ₹ crore): Project 1 Project 2 Project 3 Project 4 Project 5Year 0 (Initial investment) -1,200 -1,500 -700 -700 -300Year 1 500 400 200 300 100Year 2 500 500 250 300 100Year 3 500 600 300 300 100Year 4 500 700 350 300 100Consider the rate of interest as 7.5%.Which of the following projects has the highest IRR ?Project 2Project 1Project 4Project 3Project 5
An investor is considering three projects, A, B and C summarized in the table below. Investment cost Annual operating profit Project life (years)Project A -70000 17000 5Project B -90000 15000 8Project C -60000 13000 6Suppose the investor can borrow funds at an interest rate of 6%, by using the NPV rule with a 5% discount rate, he should choose project _____. When using the IRR rule, he should ____ this project.
You have two mutually exclusive projects. Both projects require initial investment of $20 million. Project 1 generated $4 million per year in perpetuity.Project 2 generated $3 million at the end of the first year and its revenue will grow 3% per year thereafter.The cash flows of both projects start at the end of the first year. <a> IRR<b> NPV, assume the cost of capital is 6%
Upgrade your grade with Knowee
Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.