If the firm had another project to which it could put that $6 million, then perhaps Project C. would become the most attractive option. However, with that $6 million uninvested, Project B. is the best option on the basis of its higher net present value.
7. I recommend Project B. because it has the highest NPV. The uninvested capital makes Project C. A lesser option. Project A leaves no uninvested capital but it has a lower NPV and IRR than Project B. Project D. offers low returns and has some uninvested capital, making is the worst of both worlds.
8. I recommend for Project B. that we use the 20/80 capital structure. This capital structure has an NPV of $5.36, which is higher than the NPV for any other project. This capital structure also has a higher MIRR than the zero leverage scenario, making it a better choice. The 50/50 structure has an even higher MIRR, but has a relatively low NPV, so low that if chosen would negate the rationale for choosing Project B. In the first place. Thus, 20% debt is the ideal capital structure for this project, offering superior NPV at a better MIRR.
9....
The gross cash flow for Year 1 for my chosen option of Project B. And 20% debt is $11 million. The tax rate is 30%. The cost of debt is 7% at that level of leverage. Thus, the after-tax net income will be $7.504 million. This is calculated as follows:
EBIT
11
Int Exp
0.28
Taxable Inc.
10.72
Taxes
3.216
Net Income
7.504
10. In this analysis, Mark is overlooking the possible uses for the uninvested portion of the $20 million for Projects C. And D. Project C. In particular has attractive returns, but the NPV suffers because only $14 million is invested. It is assumed in Mark's work that the remaining $6 is not invested elsewhere, simply because these four projects are mutually exclusive. Mark should investigate what would happen with that $6 million, should Project C. be selected. If it can be invested elsewhere in the company, the returns from that investment should be incorporated into the calculations for Project C. This should change the expected NPV, IRR and MIRR for Project C.
