Mod13 av3


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Mod13 av3

  1. 1. Module 13A CAPITAL BUDGETING FOR MUTUALLY EXCLUSIVE PROJECTS OBJECTIVE: In general, when two independent projects are evaluated using a discounted cash flow approach, the Internal Rate of Return (IRR) and Net Present Value (NPV) methods will indicate identical accept or reject decisions. However, when two projects are mutually exclusive, the two methods can give inconsistent results. This program will determine if that is the case, and will compute the NPV and IRR for each project and for the differential cash flows between the two projects. Additionally, it will display a series of NPV's at different discount rates for each of the projects. INPUTS (will appear in blue): 1) The cash outflows for projects A and B should be entered as negative numbers in cells B47 and B49, respectively. 2) The cash inflows for projects A and B should be entered in cells C47-H47 and C49-H49, respectively. Up to six cash flows can be accommodated. The annual cash flows do not have to be uniform. If there are fewer than six cash flows, leave the other cells blank. 3) The cost of capital should be entered (as a decimal) in cell D51. GRAPH: A graph will show if the NPV's for the two projects are equal at any discount rate (cost of capital). To obtain the graph, enter five discount rates in cells D76-H76. In cell C76, the discount rate is zero. The five others should be in ascending order, with one of these being the cost of capital. The intervals between the rates should be identical. At the point where the two lines intersect, the two projects have the same net present value. If the two lines intersect, then the two measures will give inconsistent results if the cost of capital is less than the rate at which they intersect. If the cost of capital is higher than the rate at which they intersect, the two measures will give consistent results. If the two lines do not intersect, then there is no inconsistency between the two measures. Press GRAPH located at bottom of screen. NET PRESENT VALUE VERSUS INTERNAL RATE OF RETURN Sample data have been entered as an example. Project t=0 t=1 t=2 t=3 t=4 t=5 t=6 A -12000 3000 7000 8000 B -10000 5000 5000 5000 Cost of capital 10.0%
  2. 2. Internal Rate of Return Project A 20.0% Project B 23.4% Net Present Value Project A 2523 Project B 2434 Delta (differential cash flows) (A-B) -2000 -2000 2000 3000 0 0 0 Net Present Value 89 Internal Rate of Return 11.2% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% Project A 6000 4117 2523 1162 -9 -1024 Project B 5000 3616 2434 1416 532 -240
  3. 3. NET PRESENT VALUE PROFILES 7000 6000 5000 4000 Net Present Value 3000 2000 1000 0 -1000 -2000 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% Discount rate Row 78 Row 80