InvestmentDecisionRules:CapitalBudgetingMethods
Supposeyou areacapitalbudgetinganalystforacompanyconsideringinvestments ineight projects listed in Exhibit 1.Thecompanyhasdetermined that theycanundertakeeachoftheseprojects
andhaveforecasted the project cash flowsfromeach project in Exhibit
1.
The chieffinancialofficer ofyour companyhasaskedyou
to rank theprojects and recommendthe fourbest thatthecompanyshould
accept. You will rank the projectsbased on quantitative decisionsalone.Nootherprojectcharacteristicsarerelevant in the selection,exceptthatmanagementhasdeterminedthat
projects 5 and 6 are mutuallyexclusive.All
otherprojects areindependent.
All the projects require the same initial investment, $5million.Moreover,allarebelievedto
be ofthe sameriskclass.Assume that 12% is an appropriatediscountrate (some
officers ofthe companyhavesuggested that thediscount rateshould be higher).
Assigned #7 and #8
1. Explain
why the MIRR of project #7 is greater than this projects IRR.
2. What
could the cash flows of #7 and #8 represent in the real world?
3. Ho
would you rank the projects (if possible) 1-7?
Exhibit 1
ProjectCashFlows (dollars in thousands)
Project:
1
2
3
4
5
6
7
8
Initialcost:
-5000
-5000
-5000
-5000
-5000
-5000
-5000
-5000
Year
1
650
3,000
0
700
2500
-550
670
625
2
650
1400
0
900
1700
-50
670
625
3
650
840
0
915
900
60
670
625
4
650
650
0
920
700
450
670
625
5
650
390
0
925
500
800
670
625
6
650
235
0
930
300
1100
670
625
7
650
141
0
940
200
1350
670
625
8
650
85
0
950
150
1500
670
625
9
650
51
0
960
100
1625
670
625
10
650
31
0
970
60
1725
670
625
11
650
19
0
980
30
1810
670
625
12
650
11
0
990
20
1885
670
625
13
650
7
0
1000
10
1935
670
625
14
650
4
0
1100
5
1975
670
625
15
5000
3
22000
-5000
5
2000
670
5625
InvestmentDecisionRules:CapitalBudgetingMethodsSupposeyou areacapitalbudgetinganalystforacompanyconsideringinvestments ineight projects listed in Exhibit 1.Thecompanyhasdetermined that theycanundertakeeachoftheseprojects
andhaveforecasted the project cash flowsfromeach project in Exhibit
1.The chieffinancialofficer ofyour companyhasaskedyou
to rank theprojects and recommendthe fourbest thatthecompanyshould
accept. You will rank the projectsbased on quantitative decisionsalone.Nootherprojectcharacteristicsarerelevant in the selection,exceptthatmanagementhasdeterminedthat
projects 5 and 6 are mutuallyexclusive.All
otherprojects areindependent.All the projects require the same initial investment, $5million.Moreover,allarebelievedto
be ofthe sameriskclass.Assume that 12% is an appropriatediscountrate (some
officers ofthe companyhavesuggested that thediscount rateshould be higher).Assigned #7 and #81. Explain
why the MIRR of project #7 is greater than this projects IRR.2. What
could the cash flows of #7 and #8 represent in the real world?3. Ho
would you rank the projects (if possible) 1-7?Exhibit 1ProjectCashFlows (dollars in thousands)Project:12345678Initialcost:-5000-5000-5000-5000-5000-5000-5000-5000Year16503,00007002500-5506706252650140009001700-50670625365084009159006067062546506500920700450670625565039009255008006706256650235093030011006706257650141094020013506706258650850950150150067062596505109601001625670625106503109706017256706251165019098030181067062512650110990201885670625136507010001019356706251465040110051975670625155000322000-5000520006705625
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