Caledonia's Project Has a Net Essay

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The discounted payback for each project is also in the fifth year, but further along in the fifth year for Project a compared to the simple payback.

The net present value of Project a is $18,269. The net present value for Project B. is $18,690. The IRR for Project a is 18%, and the IRR for Project B. is 15%. (see Appendix B)

The cause of the ranking conflict would be that the cash flows for Project B. are weighted towards the fifth year, whereas the flows for Project a are spread more evenly throughout the project's life. The ability to re-invest the earlier flows from Project a allows that project to have a higher IRR despite having a lower NPV.

The project that should be selected is Project B. This project has the higher net present value, and that should be the criteria for determining between two mutually exclusive projects.

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It is reasonable to assume that because this project's flows all come in the fifth year that it is a riskier project (the IRR supports this contention), but if that is the case, the discount rate should be higher for that project. Using the same discount rate implies that the risk for each project's cash flows is equivalent.

Appendix a: Net Present Value Calculation

Units Sold

70,000

120,000

140,000

80,000

60,000

Price

Year

0

1

2

3

4

5

Cost

-7900000

Installation

-100000

Revenue

21

36

42

24

15600000

VC

-12600000

-21600000

-25200000

-14400000

-10800000

Fixed Costs

-200000

-200000

-200000

-200000

-200000

WC

-100000

-2100000

-3600000

-4200000

-2400000

-1560000

WC End

13960000

Tax Benefit

537200

537200

537200

537200

537200

Cash Flows

-8100000

6637200….....

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