1. THE INVESTMENT DETECTIVE
This case presents the cash flows of eight unidentified investments, all of equal initial investment size. The student’s task is to rank the projects. The first objective of the case is to examine critically the principal capital-budgeting criteria. A second objective is to consider the problem that arises when net present value (NPV) and internal rate of return (IRR) disagree as to the ranking of two mutually exclusive projects. Finally, the case is a vehicle for introducing the problem created by attempting to rank projects of unequal life and the solution to that difficulty criterion.

Please answer following questions
1. What analytical criteria can we use to rank the projects? How do you define each criterion? Please evaluate each project using all investment criteria we learned during the class. 2. Which of the two projects, 7 or 8, is more attractive? How sensitive is our ranking to the use of high discount rates? Why do NPV and IRR disagree? 3. What rank should we assign to each project? Why do payback and NPV not agree completely? Which criterion is best? 4. Are those projects comparable on the basis of NPV? Because the projects have different lives, are we really measuring the “net present” value of the short-lived projects?

(Question 4 Hint)
Comparisons based on standard NPV ignore the inequality of project lives such as those in the case. Simply put, short-lived projects could be replicated within the life of the longest project (for example, project 6 could be replicated 15 times within the life of project 3), producing very different time profiles of cash flows for the projects. One solution to this problem is the so-called replacement-chain approach, in which shortlived projects are replicated out to a horizon common with the long-lived projects; the NPV on the entire chain is then calculated and compared with the NPV of the other chain. This approach can be cumbersome, however, in problems with many alternative...

...Case 17 – The InvestmentDetective
The case of the InvestmentDetective laid out the cash flows for us in each of eight different projects. Before doing any calculations we came up with the assumption that we could not rank the projects simply by inspecting the cash flows.
Without the ability to rank the projects based off of cash flows solely, we had to use some analytical criteria as a capital budgeting analyst to provide some thorough support and reasoning for how we ranked the four best projects. In this case we are only using quantitative considerations that we deem to be relevant and no other project characteristics are deciding factors in our selection of the best four projects. When coming up with our calculations to rank the four best projects we have to take into account that each project is going to require an initial investment of two million dollars and in using historical data from other capital budgeting analysts in the firm, we deemed a ten percent discount rate as an appropriate figure for our calculations.
The analytical criteria in which we feel we gives us the best results to help us choose the top four projects are Net Present Value, Internal Rate of Return, and the Payback Period calculation. We are basing our rankings solely on the results we receive from our Net Present Value calculations because we feel this method to be the most consistent and it also takes into...

...The InvestmentDetective Case
We can use normal investment to calculate the data, but we also can do it as reinvestment to invest every project for the same years. For every question, I will give answers for both normal investment and reinvestment.
1. We can rank the projects simply by the cash flow data.
Normal investment:
Rank
1
2
3
4
5
6
7
8
Project number
3
8
6
1
5
7
4
2
Cash flow
8000
2150
200
1310
2200
560
1561
165
Reinvestment:
Rank
1
2
3
4
5
6
7
8
Project number
3
8
6
1
5
7
4
2
Cash flow
8000
4300
3000
2620
2200
1680
1561
825
However, the rank simply inspected by the cash flows is not the best method to evaluate the projects. Because this method does not consider time period, WACC, Net present value and other factors. All the factors could affect the value of project.
2. To evaluate the investment projects, we can use 5 main methods, NPV, IRR, MIRR, payback and discount payback. Each method has different advantage to evaluate the investment projects. It is better to use NPV and MIRR methods to evaluate the projects. NPV can provide basic accurate methods to use time value of money to estimate investments. MIRR includes both WACC and reinvestment rate; therefore, it is more accurate to evaluate the investments.
3. First, NPV is the most common and useful method. It provides a...

...simply inspecting the cash flows. However, it is not a good method to rank the projects. In order to ensure that the investment projects selected have the best chance of increasing the value of the firm, we need tools to evaluate the merits of individual projects and to rank competing investments. In this case, our group using some tools which are Payback Period, Net Present Value (NPV) , Profitability Index (PI), and Internal Rate of Return (IRR). We are only using quantitative considerations that we think to be relevant and no other project characteristics are deciding factors in our selection of the best four projects.
Payback Period
NPV
PI
IRR
Sum of Cash Flow Benefits
Excess of cash flow over initial investment
Project 1
6 years 22 days
$ 73.09
104%
10.87%
3310
1310
Project 2
2 years
($ 85.45)
96%
6.31%
2165
165
Project 3
15 years
$ 393.92
120%
400%
10000
8000
Project 4
6 years 18 days
$ 228.82
111%
12.33%
3561
1561
Project 5
7 years 1 month 20 days
$ 129.70
106%
11.12 %
4200
2200
Project 6
1 year
0
100%
10%
2200
200
Project 7
1 year 10 months 20 days
$ 165.04
108%
15.26%
2560
560
Project 8
6 years 14 days
$ 182.98
109%
11.41%
4150
2150
When coming up with our calculations to rank the four best projects we have to take into account that each project is going to require an initial investment of two million dollars and in using historical data...

...For the exclusive use of S. YAN
￼UV0072 Version 2.2
￼THE INVESTMENTDETECTIVE
The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm’s capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital-budgeting analyst, therefore, is necessarily a detective who must winnow bad evidence from good. Much of the challenge is in knowing what quantitative analysis to generate in the first place.
Suppose you are a new capital-budgeting analyst for a company considering investments in the eight projects listed in Exhibit 1. The chief financial officer of your company has asked you to rank the projects and recommend the “four best” that the company should accept.
In this assignment, only the quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive.
All the projects require the same initial investment, $2 million. Moreover, all are believed to be of the same risk class. The firm’s weighted average cost of capital has never been estimated. In the past, analysts have simply assumed that 10% was an appropriate discount rate (although certain officers of the company have recently asserted that...

...Case Write-Up: The InvestmentDetective
Case Summary
The purpose of this case is to become a capital budgeting analyst and evaluate which set of free cash flows for 8 projects will result in the most effective investment for a firm’s capital. The objective given is to rank the four best that the company should accept. The case is broken down into three separate steps including the given information about estimated cash flows (inflows & outflows), determining the appropriate discount rate, and evaluating the cash flows using the IRR (Internal Rate of Return), MIRR (Modified Internal Rate of Return), NPV (Net Present Value), and other metrics. Each project is chosen solely on the basis of the quantitative analysis. Here are some factors to consider for this case: Each project has the same initial investment of $2 million; in addition, all are believed to be of the same risk class. The managers have determined that projects 7 and 8 are mutually exclusive. The issue is that the WACC has never been officially estimated and in the past the discount rate has been assumed at 10 percent (however, certain officers have asserted the discount rate to be higher).
Ranking Projects
Ranking projects simply through the inspection of cash flows is inadequate due to the time value of money and cost of capital of companies; the only piece of information that can be derived from looking at the cash flows is the amount of time it would...

...your three investment choices using three criteria, the net present value and internal rate of return and payback period. In analysing the following investments I have not taken into account the effects of taxation
Ranking of investmentsInvestment 3 has the best rating using the three analysis tools, the initial investment is paid back after 5.05 years, followed by investment 2
Limitations of analysis using NPV, IRR and PP
The results given from Net present value are affected by the discount rate and we have to assume that the rate will be the same over the life of the investment, however in reality the costs of money and thus discount rate can change monthly and it is unrealistic to assume that the discount rate will remain the same over the investment life
The internal rate of return does not factor in inflation or when applicable the costs of borrowing money in the rate it gives thus it is a higher rate than it should be as it ignores other costs.
Payback period does not put any value on returns after the initial investment is recouped, it also does not consider any additional outgoings.
Which investment should be chosen?
When selecting which investment risk has to be considered as well as what the other options are. Investment 1 and 2 carry virtually the same level of risk so...