The Investment Detective Case

Topics: Net present value, Internal rate of return, Bond Pages: 6 (671 words) Published: March 23, 2014
Case Analysis

Actually, we can rank the projects by 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 from other capital budgeting analysts in the firm, we assume that the appropriate discount rate is ten percent for our calculations. After calculating it, we have found the number for every tool on every project, and rank the projects.

Cash Flows
Payback Period
NPV
PI
IRR
Ranking 1
Project 3
Project 6
Project 3
Project 3
Project 3
Ranking 2
Project 5
Project 7
Project 4
Project 4
Project 7
Ranking 3
Project 8
Project 2
Project 8
Project 8
Project 4
Ranking 4
Project 4
Project 8
Project 7
Project 7
Project 8
Ranking 5
Project 1
Project 4
Project 5
Project 5
Project 5
Ranking 6
Project 7
Project 1
Project 1
Project 1
Project 1
Ranking 7
Project 6
Project 5
Project 6
Project 6
Project 6
Ranking 8
Project 2
Project 3
Project 2
Project 2
Project 2

The result is that ranking using capital budgeting techniques differ from the ranking obtained by simple inspection of the cash flows. Even project’s ranking using different methods give a different ranking. Therefore, we are basing our rankings only from the results that we receive from our Net Present Value calculations because we feel this method to be the most consistent and it also takes into account all of the cash flows as well as the time value of money. Most important, The NPV measures how much wealth a project creates or destroys for shareholders. The NPV approach has the clearest link to maximize shareholder wealth and become the “gold standard” for evaluating investment opportunities.

Because we are using the NVP method, the ranking of the project is: Ranking 1
Ranking 2
Ranking 3
Ranking 4
Ranking 5
Ranking 6
Ranking 7
Ranking 8
Project 3
Project 4
Project 8
Project 7
Project 5
Project 1
Project 6
Project 2

Therefore, the best four projects are Project 3 (NPV = $393.92), Project 4 (NPV = $228.82), Project 8 (NPV = $182.98), and Project 7 (NPV = $165.04)

What kinds of real investment projects have cash flows similar to those in Exhibit?

Project 1 is mostly similar to investment in a coupon bond, where you are able to get coupon payments periodically at the end of the period when you get the principal. Project 2 and 6 are most likely like the actual venture capital project where bulks of cash inflows occurs at the end while some of the cash inflows takes place at the beginning. Project 3 is related to zero coupon bond where you can purchase the bond at a specific price and you receive a big cash inflow at the end of...
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