It is the job of every financial analyst to make sure solid recommendations are given to the Controller, CFO, or the Board of Directors. Sometimes it can be difficult to know which quantitative analysis to use and why to use a particular one. There are certain times when simply using the sum of the Cash Flows will be sufficient. For example, if you do not want to take into account the time/value of money, or factor in the risk of a project, then you could use the total of the cash flows. Usually the top four quantitative measures in order are: 1) NPV 2) MIRR 3) IRR 4) Profitability Index. For the purpose of this case, I have used those top four in addition to: 5)Payback period and 6) Discounted Payback Period.
For the purpose of this case, the CFO has asked that the “four best” projects be ranked and recommended as to which the company should accept. These top four rankings are reflected with each of the six (6) quantitative ranking calculations below; however, if asked to select just one of the rankings, then NPV would be selected.
That being said, the top four projects in the NPV ranking (assuming a 10% WACC) are: Project 3, Project 4, Project 8, and Project 5. Although Project 7’s NPV is higher than Project 5, it is not listed because it is mutually exclusive with Project 8 and they cannot be ranked together. More of these calculations are outlined and explained in the “Calculations” section below.
1. Can you rank the projects simply by inspecting the cash flows?
a. Absolutely. However, this is not recommended to be the best thing to do. By analyzing just the cash flows, you are not taking into account the time/value of money. A dollar earned today is not worth the same as a dollar earned in the future, 1, 5, or 15 years down the road. If you want to compare cash flows, then you must bring all cash flows to the present. This is done by taking into account the time/value of money....