FIN 340 Case One - The Investment Detective Case PDF

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The Investment Detective Case...

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The Investment Detective 1. Figure 1 shows the NPV, IRR, and payback period for each of the eight investment opportunities using a WACC of 10%, calculated in Microsoft Excel using the NPV and IRR functions. An asterisk on the original case document denoted year in which payback was achieved, however, upon double checking these values, we found that full payback for Project 4 actually occurred in year 7, as opposed to year 6 denoted by the original document.

2. Projects 3, 4, 5, and 7 are the best projects to accept because of their high NPV returns, satisfactory IRR metrics, and suitable payback periods. We chose 7 over 8 because while project 8 has a higher NPV, project 7 has a higher IRR and a faster payback period. These metrics reflect the project’s greater risk tolerance, remaining economically feasible even if the firm’s WACC increases. Depending on the financing structure of the project (more equity and less debt), the firm could be vulnerable to swings in its cost of equity arising from market instability. Additionally, project 7 generates considerable cash flows earlier than project 8, meaning that this project will be under less risk from natural economic fluctuations. Another consideration is the opportunity cost incurred by choosing project 8 (which ties up the firm’s capital for a couple years past project 7). The returns from project 7 could potentially be reinvested and generating returns while project 8 is still underway. Although the “Golden rule” of financial decision making states to select the project with the highest NPV (project 8 over 7), we are of the opinion that the discussed advantages of Project 7 make up for its lower NPV returns. 3. With a WACC of 12%, we would only partake in projects 4 and 7. These are the only projects that have a positive NPV (Figure 2) after the change to the WACC. The other six projects NPVs

dropped below zero, resulting in a loss. It would be worthwhile to instead use the $4 million allocated for 2 other projects on other endeavors. Figure 1:

Figure 2:...