Please show calculation and explain please 20 points Bumbles

Please show calculation and explain please

(20 points) Bumble\'s Bees, Inc. has identified the following two mutually exclusive projects Project A - $17,000 8,000 7,000 5,000 3,000 Project IB $17,000 2,000 5,000 9,000 9,500 Year 0 4 (a) (b) (c) (d) (e) What is the IRR for each of the projects? If you apply the IRR decision rule, which project should the company accept? If the required rate is 11 percent, what is the NPV for each of the projects? Which project will you choose if you apply the NPV rule? Calculate the payback periods. Which project will you choose if you apply the Payback Period rule? Calculate the Profitability Indexes. Which project will you choose if you apply the Profitability Index rule? What is you final decision? Explain.

Solution

a)

IRR is the rate of return the makes NPV = 0

Project A:

NPV = -17,000 + 8,000 / ( 1 + R)¹ + 7,000 / ( 1 + R)² + 5,000 / ( 1 + R)³ + 3,000 / ( 1 + R)⁴

Using trial and error method, i.e, after trying various values for R. let\'s try 15.86%

NPV = -17,000 + 8,000 / ( 1 + 0.1586)¹ + 7,000 / ( 1 + 0.1586)² + 5,000 / ( 1 + 0.1586)³ + 3,000 / ( 1 + 0.1586)⁴

NPV = 0

Therefore IRR for project A is 15.86%

Project B:

NPV = -17,000 + 2,000 / ( 1 + R)¹ + 5,000 / ( 1 + R)² + 9,000 / ( 1 + R)³ + 9,500 / ( 1 + R)⁴

Using trial and error method, i.e, after trying various values for R. let\'s try 14.69%

NPV = -17,000 + 2,000 / ( 1 + 0.1469)¹ + 5,000 / ( 1 + 0.1469)² + 9,000 / ( 1 + 0.1469)³ + 9,500 / ( 1 + 0.1469)⁴

NPV = 0

Therefore IRR for project B is 14.69%

Since project A has a higher IRR, we accept project A

Please note: It is always recommended to use a financial calculator to calculate IRR. Trial and error method can be time consuming.

b)

NPV = present value of cash inflows - present value of cash outflows

Project A:

NPV = -17,000 + 8,000 / ( 1 + 0.11)¹ + 7,000 / ( 1 + 0.11)² + 5,000 / ( 1 + 0.11)³ + 3,000 / ( 1 + 0.11)⁴

NPV = 1,520.7

Project B:

NPV = -17,000 + 2,000 / ( 1 + 0.11)¹ + 5,000 / ( 1 + 0.11)² + 9,000 / ( 1 + 0.11)³ + 9,500 / ( 1 + 0.11)⁴

NPV = 1,698.58

Since project B has a greater NPV, we accept project B

c)

Payback period of project A;

Cumulative cash flow for year 0 = -17,000

Cumulative cash flow for year 1 = -17,000 + 8,000 = -9,000

Cumulative cash flow for year 2 = -9,000 + 7,000 = -2,000

Cumulative cash flow for year 3 =  -2,000 + 5,000 = 3,000

2,000 / 5,000 = 0.4

Payback period = 2 + 0.4 = 2.4 years

Project B:

Cumulative cash flow for year 0 = -17,000

Cumulative cash flow for year 1 = -17,000 + 2,000 = -15,000

Cumulative cash flow for year 2 = -15,000 + 5,000 = -10,000

Cumulative cash flow for year 3 =  -10,000 + 9,000 = -1,000

Cumulative cash flow for year 4 = -1,000 + 9,500 = 8,500

1,000 / 9,500 = 0.1053

Payback period for project B = 3 + 0.1053 = 3.1053 years

We accept project A as it has a lower payback period

d)

Profitability index = present value of cash inflows / initial investment

Project A:

present value of cash inflows = 8,000 / ( 1 + 0.11)¹ + 7,000 / ( 1 + 0.11)² + 5,000 / ( 1 + 0.11)³ + 3,000 / ( 1 + 0.11)⁴

present value of cash inflows = 18,520.71

Profitabilty index = 18,520.71 / 17,000

Profitabilty index = 1.089

Project B:

Present value of cash inflows = 2,000 / ( 1 + 0.11)¹ + 5,000 / ( 1 + 0.11)² + 9,000 / ( 1 + 0.11)³ + 9,500 / ( 1 + 0.11)⁴

Present value of cash inflows = 18,698.58

Profitability index = 18,698.58 / 17,000

Profitability index = 1.099

We select project B as it has a higher profitablitiy index

e)

When project are mutually exclusive, we always look at the NPV criteria. Project B has a greater NPV, therefore we select project B.