Chapter 9 Solutions Review Questions
2.
The payback period is the exact amount of time required to recover the firm’s initial investment in a project. In the case of a mixed stream, the cash inflows are added until their sum equals the initial investment in the project. In the case of an annuity, the payback is calculated by dividing the initial investment by the annual cash inflow.
3.
The weaknes weaknesses ses of using using the the payback payback period period are (1) (1) no explicit explicit consid consideratio eration n of sharehol shareholders’ ders’ wealth wealth;; (2) failure to take fully into account the time factor of money; and (3) failure to consider returns beyond the payback period and, hence, overall profitability of projects.
5.
Acceptance Acceptance criteri criterion on for the net net present present value value method method is is if NPV NPV > 0, accept; accept; if NPV < 0, reject. reject. If the the firm undertakes projects with a positive NPV, the market value of the firm should increase by the amount of the NPV.
6.
The internal rate of return on an investment is the discount rate that would cause the investment to have a net present value of zero.
7.
If a project’ project’ss internal internal rate rate of return return is greater greater than than the the firm’s firm’s cost cost of capital capital,, the project project should should be accepted; otherwise, the project should be rejected. If the project has an acceptable IRR, the value of the firm should increase.
Answers to Warm-Up Exercises E9-1. -1.
Payback Per Period
Answer:
E9-2 E9-2..
The payback period for Project Hydrogen is 4.29 years. The payback period for Project Helium is 5.75 years.
Net Pre Present sent Valu Valuee
Answer:
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Year
Cash Inflow
1 2 3 4 5
$400,000 375,000 300,000 350,000 200,000 Total
Present Value
$377,358.49 333,748.67 251,885.78 277,232.78 149,451.63 $1,389,677.35
NPV = $1,389,677.35 −$1,250,000 = $139,677.35 YES
E9-4 E9-4::
Inte Intern rnal al Rate Rate of Retu Return rn
Answer:
You may use a financial calculator to determine the IRR of each project. Choose the project with the higher IRR. Project T-Shirt
PV = −15,000 N= 4 PMT = 8,000 Solve for I
IRR = 39.08%
Project Board Shorts
PV = −25,000 N= 5 PMT = 12,000 Solve Solve for for I IRR = 38.62% Based on IRR analysis, Billabong Tech should choose project T-Shirt. P9-1 P9-1..
LG 2: 2: Pay Payba bacck Pe Perio riod
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(a) $42,0 42,00 00 ÷ $7,000 = 6 years (b) The company company should should accept accept the projec project, t, since 6 < 8. P9-4.
LG 3: NPV
(a) (a) $3,2 $3,246 46.2 .26 6 Accept (b) −$5,130.61 Reject (c) (c) $3,1 $3,115 15.6 .65 5 Accept
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P9-5 P9-5..
LG 3: NPV NPV for for Vary Varyin ing g Cost Cost of of Capt Captia iall a. Calculator solution: $2,674.63 Accept; positive NPV
b. Calculator solution: $838.19 Accept; positive NPV
c. Calculator solution: −$805.68 Reject; negative NPV P9-11. P9-11. LG 4: 4: Inter Internal nal Rate Rate of Retu Return rn Complete B and C Only Project B
Calculator solution: IRR
=
8.62%
The firm’s maximum cost of capital for project acceptability would be 8% (8.62%). Project C
Calculator solution: IRR
=
25.41%
The firm’s maximum cost of capital for project acceptability would be 25% (25.41%).
Answers to Web Exercises
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