8 capital budget_solution.docx

IRR Answer: b.(11.3) IRRAnswer: b .Other things held constant, an increase in the cost of capital will result in a decrease in a projects IRR.a.Trueb.FalseNPV and IRRAnswer: b.(11.4) NPV and IRRAnswer: b .If a projects NPV exceeds its IRR, then the project should be accepted.a.Trueb.FalseMutually exclusive projectsAnswer: a.(11.4) Mutually exclusive projectsAnswer: a .Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV.a.Trueb.FalseNPVAnswer: c.(11.2) NPVAnswer: c .Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.a.A projects NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC.b.The lower the WACC used to calculate it, the lower the calculated NPV will be.c.If a projects NPV is less than zero, then its IRR must be less than the WACC.d.If a projects NPV is greater than zero, then its IRR must be less than zero.e.The NPV of a relatively low risk project should be found using a relatively high WACC.IRRAnswer: e.(11.3) IRRAnswer: e The IRR assumes reinvestment at the IRR, and that is generally not as valid as assuming reinvestment at the WACC, as with the NPV.Which of the following statements is CORRECT?a.One defect of the IRR method is that it does not take account of cash flows over a projects full life.b.One defect of the IRR method is that it does not take account of the time value of money.c.One defect of the IRR method is that it does not take account of the cost of capital.d.One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until some time in the future.e.One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.NPV (constant cash flows; 3 years)Answer: a.(11.2) NPV (constant cash flows; 3 years)Answer: a WACC: 10.00%Year:0123Cash flows:-$1,000$500$500$500NPV = $243.43.Edmondson Electric Systems is considering a project that has the following cash flow and WACC data. What is the projects NPV? Note that if a projects projected NPV is negative, it should be rejected.WACC:10.00%Year:0123Cash flows:-$1,000$500$500$500a.$243.43b.$255.60c.$268.38d.$281.80NPV, IRR, and payback-nonalgorithmicAnswer: d.(Comp: 11.2,11.3,11.8) NPV, IRR, and payback-nonalgorithmicAnswer: d Payback = 2 + $300/$500 = 2.6 yearsUsing the cash flow register, calculate NPV and IRR:IRR = 21.22%NPV = $260.43 $260.Van Auken Inc. is considering a project that has the following cash flows:YearCash Flow0-$1,0001400230035004400The companys WACC is 10%. What are the projects payback, internal rate of return, and net present value?a.Payback = 2.4, IRR = 10.00%, NPV = $600.b.Payback = 2.4, IRR = 21.22%, NPV = $260.c.Payback = 2.6, IRR = 21.22%, NPV = $300.d.Payback = 2.6, IRR = 21.22%, NPV = $260.e.Payback = 2.6, IRR = 24.12%, NPV = $300. MIRR (constant cash flows; 3 years)Answer: e.(11.6) MIRR (constant cash flows; 3 years)Answer: e WACC: 10.00%Year:0123Cash flows:-$800$350$350$350TV = Sum of compounded inflows:Compounded values, FVs:$423.50$385.00$350.00$1,158.50MIRR = 13.14%Found as discount rate that equates PV of TV to cost, discounted back 3 years 10%MIRR = 13.14%Alternative calculation, using Excels MIRR function.Edelman Electric Systems is considering a project that has the following cash flow and WACC data. What is the projects MIRR? Note that a projects projected MIRR can be less than the WACC (and even negative), in which case it will be rejected.WACC:10.00%Year:0123Cash flows:-$800$350$350$350a.8.62%b.9.58%c.10.64%d.11.82%e.13.14%Discounted payback (uneven CFs, 4 years)Answer: d.(11.8) Discounted payback (uneven CFs, 4 years)Answer: d WACC: 10.00%Year:01234Cash flows:-$1,000$525$485$445$405PV of CFs-$1,000$477$401$334$277Cumulative CF-$1,000-$523-$122$212$489Payback = 2.362.36.Bey Bikes is considering a project that has the following cash flow and WACC data. What is the projects discounted payback?WACC:10.00%Year:01234Cash flows:-$1,000$525$485$445$405a.1.72 yearsb.1.92 yearsc.2.13 yearsd.2.36 yearse.2.60 yearsNPV vs IRR (size differential & conflict)Answer: c.(11.4) NPV vs IRR (size differential & conflict)Answer: c WACC: 13.000%01234CFS -$1,025$375$380$385$390CFL -$2,150$750$759$768$777IRR, L = 15.577%IRR, S = 18.059%NPV, L =$116.94NPV, S =$110.47$6.46 = Value lost if use the IRR criterionNote that the WACC is constrained to be less than the crossover point, so there is a conflict between NPV and IRR, hence following the IRR rule results in a loss of value.A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method, an