1. Solution of A-B & C-D
So let's start out first of all with project A, relatively straightforward
here. Remember a very, very common mistake in this case would be to
start the NPV function like this. Remember, we don't want a discount,
what's in year zero at all, we wanna start our discounting in year
one. So what we're gonna do is we're gonna say,
we're just gonna grab that cash flow from your zero plus NPV,
open the bracket, the rate is here, 15%, comma and now we wanna
start with year one all the way to Year 10, close the bracket,
and hit Enter. Now, that we've done that calculation, let's save some time,
just do a simple copy and a paste down here. We're gonna tap F2 to
assure that it's working, it looks perfect, and we're done.
So based on just this simple metric here, we know that this negative
NPV would destroy value for the company, but this positive one would create
value, so the company would only advance with project B and not project
A. Let's hop over to tab C D now and take a look
at the solution here. All right, let's start by putting in a very
similar formula here for NPV, equals, its negative cash flow, we're gonna
say plus NPV, open the bracket, the rate is here,
15, let's grab the cash flows from year one all the way to
the end, close the bracket and hit Enter. Now for the
IRR, equals IRR, open the bracket, we're just gonna grab all of the
cash flows like this and hit Enter. And now for the profitability,
index equals open bracket the NPV, and we wanna add the investments,
so we're gonna subtract this negative cash flow here, close the bracket
divided by negative, this figure here, and we're gonna hit Enter.
Now to save some time, let's take these three formulas, copy them and
we're gonna paste them down here, and we have all the check boxes
over here, so now let's analyze the results.
So let's remember up here that we said that the company only has
sufficient capital to invest in one project, so which one to choose?
Well, we can see here that the NPVs are very, very close,
almost equal in fact. So we wanna look to the profitability index,
we can see that both are above one, but this one is substantially
higher, so we would definitely be choosing project C here. Well done.
2. Let's practice!