question archive Sky Fly, Inc is a fast growing drone manufacturer
Sky Fly, Inc is a fast growing drone manufacturer
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Sky Fly, Inc is a fast growing drone manufacturer. The annual rate of return of Sky Fly's stock has been 20% over the past few years. Company managers believe 20% is a good estimate for the firms' cost of capital. Sky Fly's CEO, Dane Cooper, believes the company needs to continue to invest in projects that offer the highest possible returns. Currently, the company is reviewing two separate projects. Project E involves expanding production capacity. Project I involves introducing one of the firms' drones into a new market. The following table shows the projected cash flows for each project. Year E I 0 -3,500,000 -500,000 1 1,500,000 250,000 2 2,000,000 350,000 3 2,500,000 375,000 4 2,750,000 425,000 Discuss Calculate the NPV, IRR, and PI for both projects. Rank the projects based on their NPV, IRR, and PI. The firm can only afford to take on one investment. Which project will the CEO likely favor? What do you think the company should do?
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Answer:
| Year | Project E | Project I |
| 0 | -3500000 | -500000 |
| 1 | 1500000 | 250000 |
| 2 | 2000000 | 350000 |
| 3 | 2500000 | 375000 |
| 4 | 2750000 | 425000 |
| NPV | 1911844.14 | 373360.34 |
| IRR | 43.70% | 52.33% |
| PI | 1.55 | 1.75 |
On the basis of NPV, Project E is higher. On the basis of IRR and Profitability index, project I is betetr.
The CEO will prefer the IRR method and take on Project I since the rate of return is maximized. However, since the firm can only take on one investment, it should take Project E. This is because Project E is adding greater value to the business.
Calculations as below
PFA
