Last Tuesday, Blue Hamster Manufacturing Inc. lost a portion of its planning and financial data when both its main and its backup servers crashed. The company’s CFO remembers that the internal rate of return (IRR) of Project Delta is 11.3%, but he can’t recall how much Blue Hamster originally invested in the project nor the project’s net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Delta. They are:
|
Year |
Cash Flow |
|---|---|
| Year 1 | $1,800,000 |
| Year 2 | $3,375,000 |
| Year 3 | $3,375,000 |
| Year 4 | $3,375,000 |
The CFO has asked you to compute Project Delta’s initial investment using the information currently available to you. He has offered the following suggestions and observations:
| • | A project’s IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows—when the cash flows are discounted using the project’s IRR. |
| • | The level of risk exhibited by Project Delta is the same as that exhibited by the company’s average project, which means that Project Delta’s net cash flows can be discounted using Blue Hamster’s 9% WACC. |
Given the data and hints, Project Delta’s initial investment is (?) , and its NPV is (?) (rounded to the nearest whole dollar).
A project’s IRR will (Increase, Decrease, Stay the same) if the project’s cash inflows increase, and everything else is unaffected.
Cash Flows:
Year 1 = $1,800,000
Year 2 = $3,375,000
Year 3 = $3,375,000
Year 4 = $3,375,000
Internal Rate of Return = 11.30%
Initial Investment = $1,800,000/1.1130 + $3,375,000/1.1130^2 +
$3,375,000/1.1130^3 + $3,375,000/1.1130^4
Initial Investment = $8,988,943
WACC = 9.00%
Net Present Value = -$8,988,943 + $1,800,000/1.09 +
$3,375,000/1.09^2 + $3,375,000/1.09^3 + $3,375,000/1.09^4
Net Present Value = $500,157
Given the data and hints, Project Delta’s initial investment is $8,988,943, and its NPV is $500,157.
A project’s IRR will increase if the project’s cash inflows increase, and everything else is unaffected.
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