Allison Osthoff 6 September 2023 BFIN 423 Case 1: Investment Detective In this case I am acting as a capital-budgeting analyst for a company that is considering investments in eight different projects. I will carry out this task by using my established financial knowledge to rank the various projects and recommend the four best that the company should accept. When doing this it is important to note that only quantitative considerations are relevant and that projects 7 and 8 are mutually exclusive. All of these projects also require an initial investment of $2 million and are believed to hold the same amount of risk. The weighted average cost of capital has never been estimated I will use the assumed 10% discount rate. When evaluating the profitability of various projects quantitatively there are multiple methods that can be used to do so. Some of these methods include calculating the Net Present Value, Internal Rate of Return, Equivalent Annual Annuity, and the Profitability Index. However, since these projects don’t have equal lifetimes and projects 7 & 8 are mutually exclusive from each other, I will be focusing on mainly the Equivalent Annual Annuity formula to determine which projects should be accepted. First, I started off by calculating the NPV, IRR, E.A.A., and the profitability index of each project to compare them to each other. To calculate the NPV I used the excel function =npv then subtracted the initial investment of $2 million from each project. Based on the NPV all projects are to be accepted except #2 since it has a negative NPV value. Then I calculated the IRR by using the cash flow function on my financial calculator. However, it is difficult to use the IRR when ranking projects as it cannot be used for projects 7 and 8 since they are mutually exclusive. In addition, since project 2 had an IRR of 6.31% it will not be accepted since its cost of capital exceeds the return rate. Therefore, I calculated the Equivalent Annual Annuity by multiplying the rate times the NPV then dividing it over the annuity formula. I found this method to be the most useful in predicting which projects to accept because it accounts for the time value of money and annuitizes the values. Finally, I used the profitability index by dividing the projected NPV by the initial investment of $2 million. Which is useful as it shows the NPV per dollar invested but since there is no capital rationing in this scenario other methods are more useful. 1. When evaluating projects, you can rank them by simply inspecting the cash flows. However, it is not ideal or accurate because the cash flows do not take into consideration time value of money and the cost of capital. 2. Therefore, I used NPV, E.A.A, IRR, and the profitability index to rank these projects. While you could also use the payback period and return on investment formula, I believe the methods I used are better because the E.A.A. formula accounts for time value of money and the IRR displays the rate of return a company will receive. 3. The ranking of projects I found are 3,8,4,5,1,6,7,2 based off the E.A.A. rankings mainly while also taking the other calculations into account. Such as how project 7 must be eliminated because while it had the highest IRR it is mutually exclusive with project 8 and had a lower NPV. Along with project 2 also being eliminated since it has a negative NPV Therefore, the company should accept projects 3,8,4,5. 4. Real investment projects that I believe would have similar cash flows to those in exhibit 1 including equipment, construction projects, and land/real estate investments.
