IFM10 Ch 12 Test Bank

CHAPTER 12 CAPITAL BUDGETING: DECISION CRITERIA (Difficulty: E = Easy ! = !"#iu$ a%# T = T&u') T&u')

T*u"+,als" Easy: (12-2) P. &f cas fl&/s A%s/"*: Diff: E . Becaus Becausee prese present nt valu valuee refe refers rs to to the the value value of cash cash flows flows that that occur occur at diffe differen rentt points points in time time,, prese present nt valu values es cannot be added to determine the value of a capital budgeting project.

1

a. b.

True False

(12-2) NP. A%s/"*: Diff: E . Assu Assumi ming ng that that the the tota totall cash cash flows flows are are equa equal, l, the the !" of of a proj projec ectt whose whose cash cash flow flowss accr accrue ue rela relati tive vel# l# rapidl# is more sensitive to changes in the discount rate than is the !" of a project whose cash flows come in more slowl#.

2

a. b.

True False

(12-0) IRR A%s/"*: Diff: E . The The inte intern rnal al rat ratee of ret retur urn n is that that dis disco coun untt rate rate whi which ch equ equat ates es the the pre prese sent nt val value ue of of the the cash cash out outfl flow owss %or %or costs& with the present value of the cash inflows.

$

a. b.

True False

(12-0) IRR A%s/"*: Diff: E . (nde (nderr cer certa tain in con condi ditio tions ns,, a par partic ticula ularr proj projec ectt ma# ma# hav havee more more than than one one )**. )**. +ne +ne cond conditi ition on unde underr whic which h this situation can occur is if, in addition to the initial investment at time  -, a negative cash flow occurs at the end of the projects life.

'

a. b.

True False

(12-0) IRR A%s/"*: Diff: E . +ther things held constant, an an increase in the cost of capital discount rate will result in a decrease in a projects )**.

/

a. b.

True False

Chapter 12: Capital Budgeting: Decision Criteria

Page 1

(12-) IRR a%# NP. . )f a pro proje ject cts s !" !" ec ecee eeds ds the the pro proje ject cts s )**, )**, the then n the the proje project ct shou should ld be acce accept pted ed..

A%s/"*: Diff: E

0

a. b.

True False

(12-) Ra%i%' $"t&#s A%s/"*: Diff: E . 3iven 3iven two two mutu mutual all# l# ec eclus lusiv ivee proj projec ects ts and and a 4ero 4ero cos costt of cap capita ital, l, the the pa#b pa#bac ac5 5 metho method d and and !" !" meth method od of of selecting investments will alwa#s lead to the same decision on which project to underta5e.



a. b.

True False

(12-) !utually "3clusi4" 5*&6"cts A%s/"*: Diff: E . 7onflic 7onflicts ts betwee between n two two mutu mutuall all# # eclu eclusiv sivee proj project ects, s, where where the !" method method choose choosess o one ne projec projectt but but the the )** )** method chooses the other, should generall# be resolved in favor of the project with the higher !".

6

a. b.

True False

(12-7) !ulti5l" IRRs A%s/"*: Diff: E . The The phen phenome omeno non n calle called d 9multi 9multipl plee inte intern rnal al rate ratess of ret retur urn9 n9 ari arise sess when when two two or more more mut mutua uall# ll# ec eclus lusiv ivee projects which have different lives are being compared.

8

a. b.

True False

(12-8) !&#ifi"# IRR A%s/"*: Diff: E . The The modif modifie ied d )** )** %:)** %:)**&& metho method d has wide wide app appea eall to profe profess ssor ors, s, but but most most busin busines esss eecu eecutiv tives es pref prefer er the the !" method to either the regular or modified )**.

1-

a. b.

True False

(12-8) !&#ifi"# IRR A%s/"*: Diff: E . The mod modifi ified ed )** )** %:) %:)**& **& alwa# alwa#ss leads leads to the same same capi capital tal bud budge geting ting decisio decisions ns as the !" method method..

11

a. b.

True False

(12-8) R"i%4"st$"%t *at" assu$5ti&% A%s/"*: Diff: E . The The !" met metho hod dss assump assumptio tion n that that cash cash inflo inflows ws are are rein reinve vest sted ed at the the cost cost of capit capital al is more more reas reason onab able le than than the )**s )**s assump assumption tion that cash flows flows are reinves reinvested ted at the )**. This This ma5es ma5es the !" method method preferable to the )** method.

12

a. b.

True False

(12-9) Payac 5"*i&# A%s/"*: Diff: E . +ne +ne advan advanta tage ge of the the pa#ba pa#bac5 c5 peri period od meth method od of eval evalua uatin ting g fied fied asse assett investm investmen entt possib possibil iliti ities es is that that it provides a rough measure of a projects liquidit# and ris5.

1$

a.

Page 2

True


b.

False

(12-11) R"5lac"$"%t cai% A%s/"*: Diff: E . The The repla replace ceme ment nt chai chain, n, or commo common n life, life, appr approa oach ch is appli applica cabl blee wheth whether er two two proje project ctss with dif diffe feri ring ng lives lives are mutuall# eclusive or independent.

1'

a. b.

True False

(12-12) Ca5ital u#'"t A%s/"*: Diff: E . A firm firm should should never never und undert erta5e a5e an inve investm stment ent if acce acceptin pting g the the proje project ct woul would d cause cause an incr increas easee in the firms firms cost of capital.

1/

a. b.

True False

Medium: (12-2) NP. A%s/"*: Diff: ! . orm ormal al !roj !rojec ects ts ; and and * have have the the same same !" !" when when the the disc discou ount nt rat ratee is 4ero 4ero..
10

a. b.

True False

(12-2) NP. A%s/"*: Diff: ! . !rojec !rojectt = has has a patter pattern n of high high cash cash flow flowss in its earl earl# # life, life, while while !roje !roject ct > has a longe longerr life, life, with with large large cash cash flows late in its life. life. At the current current cost cost of capital, normal normal !rojects !rojects = and > have have identical identical !"s. ow suppose interest rates and mone# costs generall# decline. +ther things held constant, this change will cause > to become preferred to =.

1

a. b.

True False

(12-) Ra%i%' $"t&#s A%s/"*: Diff: ! . A decr decreas easee in the firms firms disc discoun ountt rate rate %r& %r& will will incr increa ease se !" !", which which could could change change the accept accept?re ?rejec jectt decisi decision on for a potential project.
16

a. b.

True False

(12-) !utually "3clusi4" 5*&6"cts A%s/"*: Diff: ! . @hen @hen consi consider dering ing two two mutu mutuall# all# eclus eclusive ive projec projects, ts, the the fina financi ncial al manag manager er shou should ld alwa alwa#s #s sele select ct that that projec projectt whose internal rate of return is t he highest provided the the projects projects have the same same initial cost .

18

a. b.

True False

(12-) IRR a%# NP. A%s/"*: Diff: ! . )f the the )** )** of nor norma mall !roje !roject ct  is gre great ater er than than the the )** )** of mutua mutuall# ll# ec eclu lusi sive ve !ro !roje ject ct  %als %also o norma normal& l&,, we can conclude that the firm will wi ll select  rather t han  if  has a !" C -.

2-


Page 3

a. b.

True False

(12-) NP. 4"*sus IRR A%s/"*: Diff: ! . The The main main rea reaso son n that that the the !" !" metho method d is reg regar arde ded d as being being con conce cept ptua uall# ll# sup super erior ior to to the )** )** metho method d for for evaluating mutuall# eclusive investments is that multiple )**s ma# eist.

21

a. b.

True False

(12-) NP. 4"*sus IRR A%s/"*: Diff: ! . The  !" !" a nd nd ) ** ** methods, w he hen used t o ev evaluate a n independent projec project, t, will lead to diffe differen rentt accept?reject decisions unless the )** is greater t han the cost of capital.

22

a. b.

True False

(12-) NP. 5*&fil" A%s/"*: Diff: ! . The The )** )** of norm normal al !roj !rojec ectt  is grea greate terr than than the the )** )** of norm normal al !ro !roje ject ct , , and and both both )** )**ss are are grea greate terr than than 4ero. Also, Also, the !" of  is greater than than the !" of  at the cost cost of capital. capital. )f the two projects projects are mutuall# mutuall# eclusive, eclusive, !roject  should definitel# definitel# be selected, selected, and the investment made, provided we have confidence confidence in the data. data. !ut another another wa#, wa#, it is impossible to draw !" profiles profiles that would would suggest suggest not !roject . accepting !roject

2$

a. True b. False (12-8) R"i%4"st$"%t *at" assu$5ti&% A%s/"*: Diff: ! 2' . )n capi capita tall budge budgeti ting ng anal anal#s #ses es,, it is poss possib ible le that that !" !" and and )** )** will will both both invol involve ve an ass assum umpt ptio ion n of reinvestment of the projects cash flows at the same rate. a. b.

True False

(12-1;) S$all usi%"ss A%s/"*: Diff: ! . =mall =mall busi busine ness sses es prob probab abl# l# ma5e ma5e less less us usee of the D7F D7F capi capita tall budge budgetin ting g techn techniqu iques es than than larg largee busine business sses es.. This ma# reflect a lac5 of 5nowledge on the part of small firms managers, but it ma# also reflect a rational conclusion that the costs of using D7F anal#sis outweigh the benefits of these methods for those firms.

2/

a. b.

True False

(12-11) R"5lac"$"%t cai% A%s/"*: Diff: ! . Altho Althoug ugh h the rep repla lace cemen mentt chain chain,, or commo common n life, life, appr approa oach ch is appe appeal alin ing g for deal dealin ing g with with proje project ctss with with different lives, it is not used in industr# because there are no projects which meet the assumptions the method requires.

20

a. b.

True False

(12-11) C&$$&% lif" c&$5a*is&%s

Page 4

A%s/"*: Diff: !


2

.

Ete Etend ndin ing g proje project ctss with with diffe differe rent nt lives lives to a comm common on life life for for compa compari riso son n purpo purpose ses, s, while while theo theore retic tical all# l# appealing, should be done onl# if there is a high probabilit# that the projects will actuall# be replicated be#ond their initial lives.

a. True b. False (12-12) Ra%i%' $"t&#s A%s/"*: Diff: ! 26 . An# cap capita itall budge budgetin ting g inves investme tment nt rule rule shou should ld depe depend nd sole solel# l# on fore foreca cast sted ed cash cash flow flowss and the the oppor opportu tuni nit# t# cost of capital. The rule itself should not be affected affected b# managers tastes, the choice of accounting method, or the profitabilit# of other independent projects. a. b.

True False

!ulti5l" C&ic": C&%c"5tual Easy: (12-0) IRR A%s/"*: Diff: E 28 . !roj !rojec ectt A has has an )** )** of 1/ 1/ perc percen ent. t. !roje !roject ct B has has an an )** )** of 16 16 perc percen ent. t. Both Both pro proje ject ctss have have the the sam samee ris5 ris5.. @hich of the following statements is most correct

a. b. c. d. e.

)f the @A @A77 is 1- percent, percent, both proje projects cts will will have a positive positive !", !", and the !" !" of !roject !roject B will will eceed the !" of !roject A. )f the @A77 @A77 is 1/ percent, the !" of !roject B will eceed the !" of !roject A. A. )f the @A @A77 is less than than 16 percent, percent, !roject !roject B will alwa#s alwa#s have a shorte shorterr pa#bac5 pa#bac5 than !roject !roject A. A. )f the @A @A77 is greater greater than 16 percent, percent, !roject !roject B will alwa#s have have a shorter pa#bac pa#bac5 5 than !roject !roject A. )f the the @A @A77 increas increases, es, the the )** )** of both both projec projects ts will will decline. decline.

(12-) Ra%i%' c&%flicts . @hic @hich h of of the the follo ollowi wing ng state tateme ment ntss is is m mos ostt cor corre recct

A%s/"*: Diff: E

$-

a. b. c. d. e.

The !" metho method d assumes assumes that that cash flows flows will be reinve reinveste sted d at the cost of capital capital while while the )** method assumes reinvestment at the )**. The !" method assumes that cash flows will be reinvested at t he ris5 free rate while the )** method assumes reinvestment at the )**. The !" metho method d assumes assumes that that cash flows flows will be reinve reinveste sted d at the cost of capital capital while while the )** method assumes reinvestment at the ris5Gfree rate. The !" !" method method does does not cons conside iderr the inflat inflation ion premi premium. um. The )** )** method does does not consider consider all relev relevant ant cash cash flows, flows, and particul particularl arl# # cash flows flows be#ond be#ond the pa#bac5 period.


Page 5

(1 (12-) NP. 5*&fil"s A%s/"*: Diff: E $1 . !rojec !rojects ts A and B have have the the same same epe epecte cted d lives lives and and initia initiall cash cash outf outflow lows. s.
A

B

r @hich of the following statements is most correct a. b. c. d. e.

!rojec !rojectt A has has the smal smaller ler cash cash flows flows in the the later later #ears. #ears. !roject A has the larger cash flows in the later #ears. @e require require informatio information n on the cost of capital capital in order order to determine determine which which project project has larger larger earl# earl# cash flows. The !" !" profile profile graph graph is is inconsiste inconsistent nt with the stateme statement nt made in the proble problem. m. one one of the statem statement entss above above is corr correct ect..

(12-) NP. a%# IRR . @hic @hich h of of the the follo ollowi wing ng state tateme ment ntss is is m mos ostt cor corre recct

A%s/"*: Diff: E

$2

a. b. c. d. e.

)f a projec projectI tIss internal internal rate of return return %)**& %)**& eceeds eceeds the cost cost of capital capital,, then then the projec projectI tIss net present present value %!"& must be positive. )f !roject A has a higher )** than !roject B, then !roject A must also have a higher !". The )** )** calculation calculation implicitl# implicitl# assumes assumes that that all cash cash flows are are reinveste reinvested d at a rate of return return equal equal to the cost of capital. Answ Answer erss a and and c are are corr correc ect. t. one one of of the the answer answerss above above is correc correct. t.

(12-) NP. a%# IRR A%s/"*: Diff: E . !roj !rojec ectt A has has an an inte intern rnal al rat ratee of retu return rn %)* %)**& *& of of 1/ perc percen ent. t. !roje !roject ct B has has an an )** )** of of 1' 1' per perce cent nt.. Both Both projects have a cost of capital of 12 percent. @hich of the following statements is most correct

$$

a. b. c. d. e.

Page 6

Both Both projec projects ts have have a positiv positivee net pres present ent valu valuee %!"&. %!"&. !roject A must have a higher !" than !roject B. )f the cost cost of capital capital were less less than 12 percen percent, t, !roject !roject B would have a higher higher )** )** than !roject !roject A. A. =tate =tateme ment ntss a and and c are are corr correc ect. t. =tate =tateme ment ntss a, b, b, and and c are are corr correc ect. t.


(12-9) Payac 5"*i&# . A major disadvantage of the pa#bac5 period method is that it

A%s/"*: Diff: E

$'

a. b. c. d. e.

)s use usele less ss as as a ris ris5 5 indic indicat ator or.. )gnores cash flows be#ond the pa#bac5 period. period. Does Does not direc directl# tl# accou account nt for for the time time value value of mone mone# #. All of the the answ answers ers above above are are corr correct ect.. +nl# +nl# ans answe wers rs b and and c are are corr correc ect. t.

(12-1;) P&st+au#it . The postGaudit is used to

A%s/"*: Diff: E

$/

a. b. c. d. e.

)mpr )mprov ovee cas cash h flow flow fore foreca cast sts. s. =timulate management to improve operations and bring results into line with forecasts. Elimina Eliminate te potentia potentiall# ll# profi profitab table le but ris5# ris5# proj project ects. s. All of the the answ answers ers above above are are corr correct ect.. Answ Answer erss a and and b are are cor corre rect ct..

(12-12) P*&6"ct s"l"cti&% A%s/"*: Diff: E . our our comp compan# an# has a cost cost of capi capital tal equal equal to 1-J. 1-J. )f the follow following ing projec projects ts are are mutu mutuall# all# eclus eclusive ive,, and and #ou #ou onl# have the information that is provided, which should #ou accept

$0

!a#bac5 %#ears& )** !" %:illions& a. b. c. d. e.

A 1 16J K'-

B / 2-J K/

7 2 2-J K$/

E / 12J K1--

A B 7 B and 7 E

(C&$5-) NP. IRR a%# !IRR A%s/"*: Diff: E . A projec projectt has has an an upGf upGfron rontt cost cost of of K1--, K1--,-----.. The projec projectI tIss @A77 is 12 percen percentt and and its its n net et pres present ent value value is K1-,---. @hich of the following statements is most correct

$

a. b. c. d. e.

The project project should should be be rejected rejected since since its its return return is less than the the @A @A77. The projectIs internal internal rate of return is greater than 12 percent. The projectI projectIss modified modified internal internal rate rate of return return is less less than 12 percen percent. t. All of the the abov abovee answ answer erss are are corr correct ect.. one one of of the the above above answer answerss is correc correct. t.

(C&$5-) Ra%i%' $"t&#s A%s/"*: Diff: E . Assu Assume me a proj projec ectt has nor norma mall cash cash flows flows %i.e %i.e., ., the the initi initial al cas cash h flow flow is nega negativ tive, e, and and all othe otherr cash cash flow flowss are are positive&. @hich of the following statements is most correct

$6

a. b. c. d. e.

All else else equal, equal, a project projectss )** incre increases ases as as the cost cost of capital capital declines. declines. All else equal, a projects !" increases as the cost of capital declines. All else equal, equal, a projec projects ts :)** :)** is unaffec unaffected ted b# changes changes in the cost cost of capital. capital. Answ Answer erss a and and b are are corr correc ect. t. Answ Answer erss b and and c are are cor corre rect ct..


Page 7

Medium: (12-2) P*&6"ct s"l"cti&% A%s/"*: Diff: ! . A comp compan an# # esti estima mate tess that that its wei weigh ghte ted d avera average ge cost cost of cap capit ital al %@A %@A77& 77& is 1- perc percen ent. t. @hic @hich h of the the following independent projects should the compan# accept

$8

a. b. c. d. e.

!roject !roject A requir requires es an upGfront upGfront ependiture ependiture of K1,---,K1,---,---- and generate generatess a net present present value of K$,2--. K$,2--. !roject B has a modified internal rate of return of 8./ percent. !roject !roject 7 requires requires an upGfront upGfront epend ependiture iture of K1,---,K1,---,---- and generate generatess a positive intern internal al rate of return return of 8. percent. !rojec !rojectt D has an inte interna rnall rate of of return return of of 8./ perc percent ent.. one one of the the proje projects cts abov abovee should should be be accep accepted ted..

(12-0) IRR . The The in inter ternal nal ra rate of retur eturn n of of a capi capita tall inv inveestme stment nt

A%s/"*: Diff: !

'-

a. b. c. d. e.

7hange 7hangess when when the the cost cost of capital capital change changes. s. )s equal to the annual net cash flows divided b# one half of the projects cost when the cash flows are an annuit#. :ust eceed eceed the the cost cost of capital capital in in order order for for the firm to accept accept the investm investment. ent. )s simil similar ar to the #ield #ield to matu maturit rit# # on a bon bond. d. Answ Answer erss c and and d are are cor corre rect ct..

(12-) NP. 5*&fil"s A%s/"*: Diff: ! . !rojec !rojects ts > and = eeach ach have have an an initia initiall cost cost of K1K1-,-,---, -, follo followed wed b# a seri series es of pos positiv itivee cash cash inflows inflows.. !rojec !rojectt > has total, undiscounted cash inflows of K10,---, while = has total undiscounted inflows of K1/,---. Further, at a discount rate rate of 1- percent, the two projects have identical !"s. @hich projects !" will be more sensitive to changes changes in the discount rate rate %
'1

a. b. c. d. e.

!roject =. !roject >. Both Both projects projects are are equall# equall# sensitiv sensitivee to change changess in the discou discount nt rate since since their !"s are are equal at all costs of capital. eithe eitherr project project is sensit sensitive ive to changes changes in the discou discount nt rate, rate, since since both have have !" profi profiles les which which are hori4ontal. The solution solution cannot cannot be determin determined ed unless unless the the timing timing of the the cash cash flows flows is 5nown. 5nown.

(12-) NP. 5*&fil"s A%s/"*: Diff: ! . Two mutua mutuall# ll# ec eclu lusi sive ve pro proje ject ctss each each hav havee a cost cost of K1-, K1-,----. -. The The tota total, l, undi undisc scou ount nted ed cas cash h flow flowss from from !roject > are K1/,---, K1/,---, while the undiscounted cash flows from from !roject = total K1$,---. Their !" profiles cross at a discount rate rate of 1- percent. @hich of the following statements best best describes this situation

'2

a. b. c. d. e.

Page 

The !" !" and and )** methods methods will select select the same same project project if the cost of of capital capital is greater greater than 1- percentL for eample, 16 percent. The !" and )** methods will select the same project if the cost of capital is less than 1- percentL for eample, 6 percent. To determine determine if a ran5ing ran5ing conflict conflict will will occur betwee between n the two projects projects the cost cost of capital capital is needed needed as well as an additional piece of information. !roject !roject > should should be selected selected at an# an# cost of of capital, capital, because because it has has a higher higher )**. )**. !roject !roject = should should be selecte selected d at an# cost cost of capital, capital, because because it it has a higher higher )**. )**.


(12-) NP. a%# IRR A%s/"*: Diff: ! . Assu Assume me that that #ou #ou are are comp compar arin ing g two two mutua mutuall# ll# ec eclus lusiv ivee proje project cts. s. @hic @hich h of the the fol follo lowin wing g stat statem emen ents ts is most correct

'$

a.

b. c.

d.

The !" !" and )** )** rules will will alwa#s alwa#s lead lead to the same decis decision ion unless unless one one or both of the the project projectss are 9nonGnormal9 in the sense of having onl# one change of sign in the cash flow stream, i.e., one or more initial cash outflows %the investment& followed b# a series of cash inflows. )f a conflict eists between the !" and the )**, the conflict can alwa#s be eliminated eli minated b# dropping the )** and replacing it with the :)**. There There will be a meaningful meaningful %as %as opposed opposed to irrelevant& irrelevant& conflict conflict onl# onl# if the projects projects !" profiles profiles cross, cross, and even then, onl# if the cost of capital is to the left of %or lower than& the discount rate at which the crossover occurs. =tate =tateme ment ntss a, b, and and c are are true true..

(12-) NP. a%# IRR . @hich ich of the follo llowing ing state tateme men nts is incorrect 

A%s/"*: Diff: !

''

a. b. c. d. e.

Assuming Assuming a project project has normal normal cash flows, flows, the !" !" will be positive positive if if the )** )** is less than than the cost cost of capital. )f the multiple )** problem does not eist, an# independent project project acceptable b# the !" method will also be acceptable b# the )** method. )f )** )**  r %the %the cost cost of of capita capital&, l&, then then !"  -. !" can be nega negative tive if the the )** )** is pos positiv itive. e. The !" !" metho method d is not not affec affected ted b# the the multipl multiplee )** prob problem. lem.

(12-) Ra%i%' $"t&#s . @hic @hich h of of the the follo ollowi wing ng state tateme ment ntss is is cor corrrect ect

A%s/"*: Diff: !

'/

a. b.

c. d. e.

Becaus Becausee discou discounte nted d pa#bac pa#bac5 5 ta5es ta5es account account of the cost cost of capital, capital, a projec projects ts discounte discounted d pa#bac pa#bac5 5 is normall# shorter than its regular pa#bac5. The !" and )** methods use the t he same basic equation, but in the !" method the discount rate is specified and the equation is solved for !", while in the )** method the !" is set equal t o 4ero and the discount rate is found. )f the the cos costt of of cap capit ital al is less than the crossover rate for two mutuall# eclusive projects !" profiles, a !"?)** conflict will not occur. )f #ou are choosin choosing g between between two projects projects which which have the same life, life, and if their !" profi profiles les cross, cross, then the smaller project will probabl# be the one with the steeper !" profile. )f the cost cost of capital is relativel relativel# # high, this will favor favor larger, larger, longerG longerGterm term projects projects over over smaller, smaller, shorterG shorterG term alternatives because it is good to earn high rates on l arger amounts over longer periods.

(12-) Ra%i%' $"t&#s A%s/"*: Diff: ! . )n comp compar arin ing g two mutu mutual all# l# ecl eclus usiv ivee proje project ctss of equal equal si4e si4e and and equal equal life life,, whic which h of the the foll follow owin ing g statements is most correct

'0

a. b. c. d. e.

The project project with with the higher higher !" ma# not not alwa#s alwa#s be the the project project with with the higher higher )**. The project with the higher !" ma# not alwa#s be the project with the higher :)**. The project project with with the higher higher )** ma# ma# not alwa# alwa#ss be the project project with the the higher higher :)**. :)**. All of the the answ answers ers above above are are corr correct ect.. Answ Answer erss a and and c are are cor corre rect ct..


Page !

(12-) !isc"lla%"&us c&%c"5ts . @hich ich of of the follo llowing ing is mo mosst co correct

A%s/"*: Diff: !

'

a.

b. c.

d. e.

The !" and )** )** rules will will alwa#s alwa#s lead to the the same decision decision in in choosing choosing between between mutuall# mutuall# eclusiv eclusivee projects, unless one or both of the t he projects are MnonGnormalN in the sense of having onl# one change of sign in the cash flow stream. The :odified )nternal *ate of *eturn %:)**& compounds cash outflows at the cost of capital. 7onflicts 7onflicts between between !" and and )** rules rules arise in in choosing choosing between between two mutuall# mutuall# eclusive eclusive projects projects %that %that each have normal cash flows& when the cost of capital eceeds the crossover point %that is, the point at which the !" profiles cross&. The discounted discounted pa#ba pa#bac5 c5 method overc overcomes omes the problems problems that that the pa#bac5 pa#bac5 method method has with cash cash flows flows occurring after the pa#bac5 period. one one of the statem statement entss above above is corr correct ect..

(12-) !isc"lla%"&us c&%c"5ts A%s/"*: Diff: ! . orm ormal al pro proje ject ctss 7 and and D are are mutua mutuall# ll# ec eclu lusi sive ve.. !roj !rojec ectt 7 has has a high higher er net net pre prese sent nt val value ue if if the the @A @A77 is is less than 12 percent, whereas !roject D has a higher net present value if the @A77 eceeds 12 percent. Both projects have a positive !" if the @A77 @A77 is 12 percent. @hich of the following statements is most correct

'6

a. b. c. d. e.

!rojec !rojectt D has has a high higher er inter internal nal rate rate of retu return. rn. !roject D is probabl# larger in scale than !roject 7. !rojec !rojectt 7 prob probabl# abl# has a faste fasterr pa#b pa#bac5 ac5.. All of the the stat stateme ements nts above above are are corr correc ect. t. Answ Answer erss a and and c are are cor corre rect ct..

(12-8) !&#ifi"# IRR A%s/"*: Diff: ! . @hic @hich h of the the foll follow owing ing stat statem emen ents ts is is mo most st corr correc ect t The The modi modifi fied ed )** )** %:) %:)** **&& metho methodH dH

'8

a. b. c. d. e.

Alwa#s Alwa#s leads to the same ran5ing ran5ing decision decision as !" for for independe independent nt projects. projects. +vercomes the problem of multiple rates of return. 7ompou 7ompounds nds cash cash flow flowss at the the cost cost of of capita capital. l. +vercomes +vercomes the problems problems of cash flow flow timing and projec projectt si4e that lead lead to criticism criticism of the regular regular )** )** method. Answ Answer erss b and and c are are cor corre rect ct..

(C&$5-) !isc"lla%"&us c&%c"5ts . @hic @hich h of of the the follo ollowi wing ng state tateme ment ntss is is mos mostt cor corre recct

A%s/"*: Diff: !

/-

a. b. c. d. e.

The )** )** method is appeal appealing ing to some manag managers ers becaus becausee it produc produces es a rate of return return upon which which to base decisions rather than a dollar amount li5e the !" method. The discounted pa#bac5 method solves all the problems associated with the pa#bac5 method. For independ independent ent projects, projects, the decisio decision n to accept accept or reject reject will alwa#s alwa#s be the the same using using either either the )** )** method or the !" method. All of of the the state statemen ments ts abov abovee are are correc correct. t. =tate =tateme ment ntss a and and c are are corr correc ect. t.

(C&$5-) !isc"lla%"&us c&%c"5ts . @hic @hich h of of the the follo ollowi wing ng state tateme ment ntss is is mos mostt cor corre recct

A%s/"*: Diff: !

/1

a.

Page 1"

+ne +ne of the the disa disadv dvan anta tage gess of choo choosi sing ng betw betwee een n mutu mutual all# l# ecl eclus usive ive proje project ctss on the the basis basis of the the


b. c. d. e.

discounted pa#bac5 method is that #ou might choose the project with the faster pa#bac5 period but with the lower total return. :ultiple )**s can occur in cases when project cash flows are normal, but the# are more common in in cases where project cash flows are nonnormal. @hen choosing choosing betwee between n mutuall# eclus eclusive ive projects, projects, manager managerss should accep acceptt all projects projects with )**s )**s greater than the weighted average cost of capital. All of of the the state statemen ments ts abov abovee are are correc correct. t. Two Two of the the state statemen ments ts abov abovee are are corre correct. ct.

(C&$5-) NP. IRR a%# !IRR A%s/"*: Diff: ! . Assu Assume me a proje project ct has has norma normall cash cash flows flows %tha %thatt is, the the initi initial al cash cash flow flow is neg negat ativ ive, e, and and all oth other er cas cash h flows flows are positive&. @hich of the following statements is most correct

/2

a. b. c. d. e.

All else else equal, equal, a project projectss )** incre increases ases as as the cost cost of capital capital declines. declines. All else equal, a projects !" increases as the cost of capital declines. All else equal, equal, a projec projects ts :)** :)** is unaffec unaffected ted b# changes changes in the cost cost of capital. capital. Answ Answer erss a and and b are are corr correc ect. t. Answ Answer erss b and and c are are cor corre rect ct..

(C&$5-) NP. IRR a%# 5ayac A%s/"*: Diff: ! . !rojec !rojectt  has has an interna internall rate rate of of retu return rn of of 22- perce percent. nt. !rojec !rojectt  has an inte interna rnall rate rate of of retu return rn of 1/ perc percent ent.. Both projects have a positive net present present value. @hich of the following statements is most most correct

/$

a. b. c. d. e.

!roject !roject  must must have have a higher higher net present present value value than than !roject !roject . )f the two projects have the same @A77, @A77, !roject  must have a higher net present value. !rojec !rojectt  must have have a shor shorter ter pa# pa#bac bac5 5 than !roj !roject ect . Both Both ans answe wers rs b and and c are are cor corre rect ct.. one one of of the the above above answer answerss is correc correct. t.

(C&$5-) NP. IRR a%# !IRR . @hic @hich h of of the the follo ollowi wing ng state tateme ment ntss is is m mos ostt cor corre recct

A%s/"*: Diff: !

/'

a. b. c. d. e.

)f a project project with normal normal cash flows flows has an an )** which ecee eceeds ds the cost cost of capital, capital, then the project project must must have a positive !". )f the )** of !roject A eceeds the )** of !roject B, then !roject A must also have a higher !". !". The modifie modified d internal internal rate rate of return return %:)**& %:)**& can never eceed eceed the )**. Answ Answer erss a and and c are are corr correc ect. t. one one of of the the answer answerss above above is correc correct. t.

(C&$5-) NP. IRR a%# !IRR . @hic @hich h of of the the follo ollowi wing ng state tateme ment ntss is is mos mostt cor corre recct

A%s/"*: Diff: !

//

a. b. c. d. e.

The :)** :)** method method will alwa# alwa#ss arrive arrive at the same conclu conclusion sion as as the !" !" method. method. The :)** method can overcome the multiple )** problem, while the !" method cannot. The :)** :)** method uses uses a more reaso reasonable nable assumptio assumption n about reinves reinvestment tment rates rates than the )** method. method. =tate =tateme ment ntss a and and c are are corr correc ect. t. All of the the abov abovee state statemen ments ts are are corr correc ect. t.


Page 11

Tough: (12-) NP. 5*&fil"s A%s/"*: Diff: T . our ass assis ista tant nt has has just just compl complet eted ed an an anal# anal#sis sis of of two two mutua mutuall# ll# ec eclu lusi sive ve pro proje ject cts. s. ou must must now now ta5e ta5e her her report to a board of directors directors meeting and present the alternatives for the boards consideration. To help #ou with #our presentation, #our assistant also constructed a graph with !" profiles for the two projects.
/0

a.

b.

c. d.

e.

)f the two projec projects ts have the same same investm investment ent cost, cost, and if their !" !" profile profiless cross cross once in the upper upper right quadrant, at a discount rate of '- percent, this suggests that a !" versus )** conflict is not li5el# to eist. )f the two projects !" profiles cross once, in the upper left quadrant, at a discount rate of minus 1 percent, then there wil l probabl# not be be a !" versus )** conflict, irrespective of the relative si4es of the two projects, in an# meaningful, practical sense %that is, a conflict which will affect the actual investment decision&. )f one one of the proj project ectss has a !" !" profil profilee which which crosse crossess the Gai Gaiss twice , hence the project appears to have two )**s, #our assistant must have made a mista5e. @henever @henever a conflict conflict between between !" !" and )** )** eist, then, then, if the two two projects projects have have the same initial initial cost, cost, the one with the steeper !" profile profile probabl# probabl# has less rapid cash flows. flows.
(12-) C&&si%' a$&%' $utually "3clusi4" 5*&6"cts A%s/"*: Di D iff: T . !roj !rojec ectt A has has an inte intern rnal al rate rate of ret retur urn n of 16 per perce cent nt,, while while !roj !rojec ectt B has an an inter interna nall rate rate of ret retur urn n of 10 percent.
/

a. b. c. d. e.

Page 12

The cross crossover over rate for the the two projects projects is less than 12 percen percent. t. Assuming the timing of the two projects is the same, !roject A is probabl# of larger scale than !roject B. Assumin Ass uming g that the two projects projects have have the same same scale, scale, !rojec !rojectt A probabl probabl# # has a faster faster pa#bac pa#bac5 5 than than !roject B. Answ Answer erss a and and b are are corr correc ect. t. Answ Answer erss b and and c are are cor corre rect ct..


(C&$5-) NP. IRR a%# !IRR . @hic @hich h of of the the follo ollowi wing ng state tateme ment ntss is is m mos ostt cor corre recct

A%s/"*: Diff: T

/6

a.

b.

c.

d. e.

@he @hen dea deali ling ng with with independent projects, projects, discounted pa#bac5 %using a pa#bac5 requirement of $ or less #ears&, !", )**, and modified )** alwa#s lead to the same accept?reject decisions for a given project. @hen dealing with mutually exclusive projects, the !" and modified )** methods alwa#s ran5 projects the same, but those ran5ings can conflict with ran5ings produced b# the discounted di scounted pa#bac5 and the regular )** methods. :ultip :ultiple le rates rates of return return are possible possible with with the regular regular )** method method but not with the modifie modified d )** method, and this fact is one reason given b# the tetboo5 for favoring :)** %or modified )**& over )**. =tate =tateme ment ntss a, b, b, and and c are are false false.. =tate =tateme ment ntss a and and c are are tru true. e.

(C&$5-) NP. IRR a%# !IRR . @hic @hich h of of the the follo ollowi wing ng state tateme ment ntss is is cor corrrect ect

A%s/"*: Diff: T

/8

a. b. c. d. e.

There There can never never be a conflict conflict betwee between n !" and )** decisio decisions ns if the decisio decision n is related related to a normal normal,, independent project, i.e., !" will never indicate acceptance if )** indicates rejection. To find the :)**, we first compound 7Fs at the regular )** to find the T", and and then we discount the T" at the cost of capital to find the !". The !" !" and )** methods methods both both assume assume that that cash cash flows flows are reinve reinvested sted at at the cost cost of capital capital..
!ulti5l" C&ic": P*&l"$s Easy: (12-2) NP. A%s/"*: Diff: E . As the the direc directo torr of capi capita tall budge budgetin ting g for for Denve Denverr 7orpo 7orpora ratio tion, n, #ou #ou are are evalua evaluatin ting g two mutua mutuall# ll# ec eclu lusi sive ve projects with the following net cash flowsH

0-

$ '

$-,--1-,---

!roject  !roject O ear ear 7ash Flow 7ash Flow GK1--,--- GK1--,--1 /-,--1-,--2 '-,--$-,--'-,--0-,---

)f Denvers cost of capital is 1/ percent, which project would #ou choose a. b. c. d. e.

eit eithe herr proj projeect. !roject , since it has the higher )**. !rojec !rojectt O, since since it it has has the the high higher er !" !".. !rojec !rojectt , since since it it has has the the highe higherr !". !". !rojec !rojectt O, O, since since it has has the higher higher )**. )**.


Page 13

(12-2) NP. A%s/"*: Diff: E . Two Two proje projects cts being being consid considere ered d are are mutua mutuall# ll# eclus eclusive ive and have have the the foll followin owing g proj project ected ed cash cash flowsH flowsH

01

1 2 $ ' /

GK/-,--1/,02/ 1/,02/ 1/,02/ 1/,02/ 1/,02/

!roject A !roject B ear ear 7ash Flow 7ash Flow GK/-,--88,/--

)f the required rate of return on these projects is 1- percent, which would be chosen and wh# a. b. c. d. e.

!rojec !rojectt B beca because use it has has the the high higher er !" !".. !roject B because it has the higher )**. !rojec !rojectt A becaus becausee it has has the the high higher er !" !". !rojec !rojectt A becaus becausee it has has the the high higher er )**. )**. either, either, because because both both have have )**s )**s less less than than the the cost cost of capital. capital.

(12-9) Payac 5"*i&# A%s/"*: Diff: E . The =eattle =eattle 7orpor 7orporati ation on has has been been prese presente nted d with with an an inves investme tment nt oppo opportu rtunit# nit# which which will will #ield #ield cash cash flows flows of of K$-,--- per #ear in ears ears 1 through ', K$/,--- per #ear in ears ears / through 8, and K'-,--- in ear ear 1-. This investment investment will cost the firm K1/-,--K1/-,--- toda#, and the firms cost of capital is 1- percent. percent. Ass Assume ume cash flows occur evenl# during the #ear, 1?$0/th each da#. da#. @hat is the pa#bac5 period for this investment

02

a. b. c. d. e.

/.2$ #ears '.60 #ears '.-- #ears 0.12 #e #ears '.$/ #ears

Medium: (12-2) NP. A%s/"*: Diff: ! . ou are are consi conside deri ring ng the the purch purchas asee of an inve invest stme ment nt that that woul would d pa# #ou #ou K/,K/,---- per per #ear #ear for for e ears ars 1G/, 1G/, K$,--- per #ear for ears ears 0G6, and K2,--- per #ear for ears ears 8 and 1-. )f #ou require a 1' percent rate of return, and the cash flows occur at the end of each #ear, then how much should #ou be willing to pa# for this investment

0$

a. b. c. d. e.

Page 14

K1/,618.2 K21,8$.20 K$2,'1/.6/ K$6,---.-K/2,61/.1


(12-2) NP. A%s/"*: Diff: ! . The The =eatt =eattle le 7orpo 7orpora ratio tion n has been been pres presen ente ted d with an an inves investme tment nt oppo opport rtun unit# it# whic which h will #ie #ield ld endG endGof ofG# G#ea ear r cash flows of K$-,--- per #ear in ears 1 through ', K$/,--- per #ear in ears / through 8, and K'-,--- in ear ear 1-. This investment investment will cost the firm K1/-,--K1/-,--- toda#, toda#, and the firms cost of capital is 1- percent. percent. @hat is the !" for this investment

0'

a. b. c. d. e.

K1$/,86' K 16,-2$ K218,-'/ K /1,1$6 K 82,1'0

(12-0) B"f&*"+ta3 cas fl&/s A%s/"*: Diff: ! . =cot =cottt 7orpo 7orpora ratio tion nss new new proje project ct cal calls ls for for an an inves investme tment nt of of K1-,K1-,----.. )t has has an an estim estimat ated ed lif lifee of 11- #ear #ears. s. The )** has been calculated calculated to be 1/ percent. )f cash flows are evenl# evenl# distributed distributed and the ta rate is ' percent, what is the annual before-tax cash flow each #ear #ear %Assume depreciation is a negligible negligible amount.&

0/

a. b. c. d. e.

K1,88$ K$,$21 K1,/-K',86$ K/,-18

(12-8) !&#ifi"# IRR A%s/"*: Diff: ! . Al#es Al#es5a 5a =almo =almon n )nc. )nc.,, a large large salmon salmon can canni ning ng firm firm oper operat atin ing g out of "a "alde4, lde4, Ala Alas5 s5a, a, has has a new autom automat ated ed production line project it is considering. The project has a cost of K2/,--- and is epected to provide afterGta annual cash cash flows of K$,$-0 for eight eight #ears. The firms management is uncomfortable uncomfortable with the )** reinvestment assumption and prefers the modified )** approach. ou ou have calculated a cost of capital for the firm of 12 percent. percent. @hat is the projects :)** :)**

00

a. b. c. d. e.

1/.-J 1'.-J 12.-J 10.-J 1.-J

(12-8) !IRR a%# CAP! . Below Below are are the the retu return rnss of ulo uloo5 o5 7os 7osme metic ticss and and 9the 9the mar5 mar5et et99 over over a thre threeG eG#e #ear ar per period iodHH

A%s/"*: Diff: !

0

ear ear 1 2 $

uloo5 :ar5et 8J 0J 1/ 1$0 2'

uloo5 finances internall# using onl# retained earnings, and it uses the 7apital Asset !ricing :odel with a historical historical beta to determine determine its cost of equit#. equit#. 7urrentl#, 7urrentl#, the ris5Gfree ris5Gfree rate is  percent, percent, and the estimated mar5et ris5 premium is 0 percent. uloo5 is evaluating a project which has a cost toda# of K2,-26 and will provide estimated cash inflows of K1,--- at the end of the net $ #ears. @hat is this projects :)** a. b. c. d.

12.'J 10.-J 1./J 2-.-J


Page 15

e.

22.8J

(12-9) Payac 5"*i&# A%s/"*: Diff: ! . :ich :ichig igan an :attr :attres esss 7omp 7ompan an# # is cons consid ider ering ing the the pur purch chas asee of land land and and the the cons constr truc uctio tion n of a new new plant. plant. The The land, which would be bought immediatel# %at t  -&, has a cost of K1--,--- and the building, which would be erected at the end of the first #ear %t  1&, would cost K/--,---. )t is estimated that the firms afterGta cash flow will be increased b# K1--,--- starting at the end of the second #ear, and that this incremental flow would increase at a 1- percent rate annuall# over the net 1- #ears. @hat is the approimate pa#bac5 period

06

a. b. c. d. e.

2 #ears ' #ears 0 #ears 6 #ears 1- #ears

(12-9) Payac 5"*i&# A%s/"*: Diff: ! .
08

a. b. c. d. e.

$.22 #ears 1./0 #ears 2./' #ears 2.$/ #e #ears '.10 #ears

(12-9) Disc&u%t"# 5ayac . >lo# >lo#d d Ente Enterp rpri rise sess has has a proj projec ectt whic which h has has the the foll follow owin ing g cas cash h flow flowsH sH

A%s/"*: Diff: !

-

ear 1 2 $ ' /

7ash Flow GK2--,--/-,--1--,--1/-,--'-,--2/,---

The cost of capital is 1- percent. percent. @hat is the projects discounted payback  a. b. c. d. e.

Page 16

1.60$ #e #ears 2.---- #ears 2.$$$$ #e #ears 2.'8$ #ears 2.0$6- #e #ears


(12-9) Disc&u%t"# 5ayac . !ol5 !ol5 !ro !rodu duct ctss is cons consid ider erin ing g an inve invest stme ment nt pro proje ject ct with with the the follo followi wing ng cas cash h flow flowsH sH

A%s/"*: Diff: !

1

ear 1 2 $ '

7ash Flow GK1--,--'-,--8-,--$-,--0-,---

The compan# has a 1- percent cost of capital. @hat is the projectIs projectIs discounted payback  a. b. c. d. e.

1.0 #ears 1.60 #ears 2.11 #ears 2.'8 #e #ears 2.0 #ears

(12-9) Disc&u%t"# 5ayac A%s/"*: Diff: ! . Davi Daviss 7orpo 7orpora rati tion on is face faced d with with two two indep indepen ende dent nt inve invest stme ment nt oppo opport rtun unit itie ies. s. The The corpo corpora rati tion on has has an investment polic# which requires acceptable projects to recover recover all costs within $ #ears. The corporation uses the discounted pa#bac5 method to assess potential projects and utili4es a discount rate of 1- percent. The cash flows for the two projects areH

2

ear 1 2 $ '

!roject A 7ash Flow GK1--,--'-,--'-,--'-,--$-,---

!roject B 7ash Flow GK6-,--/-,--2-,--$-,---

@hich investment project%s& does the compan# invest in a. b. c. d.

!roj !rojeect A onl# nl#. either !roject A nor !roject B. !roj !rojec ectt A and and !roj !rojec ectt B. !roj !rojeect B onl onl# #.


Page 17

(C&$5-) NP. a%# 5ayac . =han =hanno non n )nd )ndus ustr trie iess is con consi side deri ring ng a proj projec ectt whic which h has has the the follo followin wing g cash cash flo flows wsHH

A%s/"*: Diff: !

$

ear 1 2 $ '

7ash Flow  K2,--$,--$,--1,/--

The project has a pa#bac5 pa#bac5 of 2./ #ears. The firmIs cost of capital is 12 percent. percent. @hat is the projectIs projectIs net present value !" a. b. c. d. e.

K /.06 K 0/.81 K1,-'8.6K2,01.$2 K$,0/.81

Tough: (12-7) !ulti5l" IRRs A%s/"*: Diff: T . Two fellow fellow fina financ ncia iall anal# anal#sts sts are are eva evalu luat atin ing g a proje project ct with with the the follo followin wing g net net cash cash flo flows wsHH

'

ear ear 1 2

7ash Flow GK 1-,--1--,--G1--,---

+ne anal#st sa#s that the project has an )** )** of between 12 and 1$ percent. The other anal#st calculates an )** of just under 6-- percent, but fears his calculators batter# is low and ma# have caused an error. ou agree to settle the dispute b# anal#4ing the project cash flows. @hich statement best describes the )** for this project a. b. c. d. e.

Page 1

There There is a sing single le )** )** of appro approima imatel tel# # 12. perc percent ent.. This project has no )**, because the !" profile does not cross the  ais. There There are multiple multiple )**s of of approimate approimatel# l# 12. percent percent and 6 percen percent. t. This This proj project ect has two imagin imaginar# ar# )**s. )**s. There There are an infinite infinite number number of )**s )**s between between 12./ percen percentt and 8- percen percentt that can define define the )** for this project.


,i%a%cial Calculat&* S"cti&% !ulti5l" C&ic": P*&l"$s Easy: (12-0) IRR A%s/"*: Diff: E . The The capita capitall budge budgetin ting g direc directo torr of =parr =parrow ow 7orp 7orpor orat atio ion n is evalu evaluat ating ing a proj projec ectt which which costs costs K2-K2--,,----,, is epected to last for 1- #ears and produce afterGta cash flows, including depreciation, of K'',/-$ per #ear. )f the firms cost of capital is 1' percent and its ta rate is '- percent, what is the projects )**

/

a. b. c. d. e.

6J 1'J 16J G/J 12J

(12-0) IRR A%s/"*: Diff: E . An insu insuran rance ce firm firm agree agreess to pa# pa# #ou #ou K$,$1 K$,$1- at the end of 22- #ear #earss if #ou #ou pa# pa# premi premiums ums of K1-K1-- per #ear #ear at at the end of each #ear for 2- #ears. Find the internal rate of return to the nearest whole percentage point.

0

a. b. c. d. e.

8J J /J $J 11J

(12-) IRR a%# $utually "3clusi4" 5*&6"cts A%s/"*: Di Diff: E . A compan compan# # is anal#4 anal#4ing ing two mutuall# mutuall# eclus eclusive ive projec projects, ts, = and and >, whos whosee cash cash flows flows are sho shown wn belowH belowH



ears

-

r  12J

P =

>

G1,1-1,--$/-/G1,1-- $--

1

2

$

P

P

P

1,/--

The compan#s cost of capital capital is 12 percent, and it can get get an unlimited amount of capital at that cost. @hat is the regular IRR %not :)**& of the better project, project, i.e., the project which the compan# should choose if it wants to maimi4e its stoc5 price a. b. c. d. e.

12.--J 1/./$J 16.02J 18.-6J 2-.'0J


Page 1!

(12-) NP. a%# IRR A%s/"*: Diff: E . our our compa compan# n# is choosi choosing ng betw between een the follo followin wing g nonGr nonGrepe epeata atable ble,, equall equall# # ris5# ris5#,, mutual mutuall# l# eclu eclusiv sivee proje projects cts with the cash flows shown below. below. ou ourr cost of capital is 1- percent. percent.
6

!roject =H

-

r  1-J

1

P

!roject >H

-

P /--

1

2 P

$ P

G1,--/-- /-r  1-J

P

2

$ P

P

'

/ P

P

P

G2,--006.0 006.0 006.0 006.0 006.0 a. b. c. d. e.

K2'$.'$ K281.K$$2./K'61.1/ K/$/.1$

(12-) NP. a%# IRR A%s/"*: Diff: E . 3ree 3reen n 3roce 3rocers rs is is deci decidi ding ng amo among ng two two mutua mutuall# ll# ec eclu lusi sive ve pro proje ject cts. s. The The two two proje project ctss have have the the foll follow owing ing cash flowsH

8

ear 1 2 $ '

!roject A 7ash Flow GK/-,--1-,--1/,--'-,--2-,---

!roject B 7ash Flow GK$-,--0,--12,--16,--12,---

The compan#Is cost of capital is 1- percent %@A77 %@A77  1-J&. 1-J&. @hat is the net present value %!"& of the project with the highest internal rate of return %)**& a. b. c. d. e.

Page 2"

K ,-8K 6,$0K11,'/K12,/1K1/,2--


(C&$5-) NP. IRR a%# 5ayac A%s/"*: Diff: E . Brau Braun n )ndu )ndust stri ries es is con consi side deri ring ng an an inves investme tment nt proj projec ectt which which has has the the fol follow lowin ing g cash cash flow flowsH sH

6-

ear 1 2 $ '

7ash Flow GK1,--'-$-/-'--

The compan#Is @A77 @A77 is 1- percent. @hat is the projectIs pa#bac5, pa#bac5, internal rate of return, and net present value a. b. c. d. e.

!a#bac !a#bac5 5  2.', 2.', )** )**  1-.1-.--J, -J, !"  K0--. K0--. !a#bac5  2.', )**  21.22J, !"  K20-. !a#bac !a#bac5 5  2.0, 2.0, )** )**  21.2 21.22J, 2J, !"  K$--. K$--. !a#bac !a#bac5 5  2.0, 2.0, )** )**  21.2 21.22J, 2J, !"  K20-. K20-. !a#bac !a#bac5 5  2.0, 2.0, )** )**  2'.1 2'.12J, 2J, !"  K$--. K$--.

(12-11) R"5lac"$"%t cai% A%s/"*: Diff: E . "ander nderhe heide iden n )nc. )nc. is consi conside deri ring ng two aver averag ageG eGri ris5 s5 alter alterna nativ tivee wa#s wa#s of produ produci cing ng its pate patent nted ed polo polo shirts shirts.. !rocess = has a cost of K6,--- and will produce net cash flows of K/,--- per #ear for 2 #ears. #ears. !rocess > will cost K11,/-- and will produce cash flows flows of K',--- per #ear for ' #ears. #ears. The compan# has a contract that requires it to produce the shirts for ' #ears, but the patent will epire after ' #ears, so the shirts will not be produced after ' #ears. )nflation is epected to be 4ero during the net ' #ears. )f cash inflows occur at the end of each #ear, and if "anderheidens cost of capital is 1- percent, b# what amount will the better project increase "ander "anderheidens heidens value

61

a. b. c. d. e.

K 0.08 K1,-86.68 K1,18.'0 K1,2$.0 K1,$12.$1


Page 21

Medium: (12-0) IRR A%s/"*: Diff: ! . 3enu 3enuine ine !ro !rodu duct ctss )nc. )nc. requ requir ires es a new new mach machine ine.. Two compa compani nies es hav havee subm submitt itted ed bid bids, s, and and #ou #ou have have bee been n assigned the tas5 of choosing choosing one of the machines. 7ash flow anal#sis indicates the followingH followingH

62

ear - GK2,--1 2 $ ' $,6

:achine A 7ash Flow GK2,--6$2 6$2 6$2 6$2

:achine B 7ash Flow

@hat is the internal rate of return for each machine a. b. c. d. e.

)**A  10JL )** B  2-J )** A  2'JL )** B  2-J )**A  16JL )** B  10J )**A  16JL )** B  2'J )**A  2'JL )** B  20J

(12-0) IRR A%s/"*: Diff: ! . @hitne @hitne# # 7ran 7ranee )nc. )nc. has the followi following ng indepe independe ndent nt investme investment nt opp opport ortuni unities ties for the coming coming #earH #earH

6$

Annual >ife !roject 7ost 7ash )nflows %ears& %ears& )** A K1-,--K1-,-- - K11,6-1 B /,--$,-/ 2 1/ 7 12,--/,080 $ D $,--1,--8 ' 1$ The )**s for !rojects A and 7, respectivel#, areH a. b. c. d. e.

10J and 1'J 16J and 1-J 16J and 2-J 16J an and 1$J 10J and 1$J

(12-0) IRR &f u%"4"% C, st*"a$ A%s/"*: Diff: ! . our com compa pan# n# is plan planni ning ng to ope open a new new gold old mine mine whic which h will will cos cost K$ mill millio ion n to buil build d, with with the the ependiture occurring at the end of the #ear three #ears #ears from toda#. The mine will bring #earGend afterGta afterGta cash inflows of K2 million at the end of the two succeeding #ears, and then it will cost K-./ million to close down the mine at the end of the third #ear of operation. operation. @hat is this projects )**

6'

a. b. c. d. e.

Page 22

1'.$0J 1-.1J 1.'2J 12.-J 21./$J


(12-0) IRR &f u%"4"% C, st*"a$ A%s/"*: Diff: ! . As the the capit capital al budg budget eting ing dir direc ecto torr for 7ha 7hape pell
6/

a. b. c. d. e.

1' G 1/J 1/ G 10J 10 G 1J 1 G 16J 16 G 18J

(12-) NP. IRR a%# Su% C&sts A%s/"*: Diff: ! . A compan compan# # just just paid paid K1K1- milli million on for a feas feasibil ibilit# it# stud# stud#.. )f the compan compan# # goes goes ahead ahead with with the projec project, t, it it must must immediatel# spend another K1-- million now, and and then spend K2- million in one #ear. #ear. )n two #ears it will receive K6- million, and in three #ears #ears it will receive K8- million. )f the cost of capital capital for the project is 11 percent, what are the projectIs !" and and )**

60

a. !"  K2.2 K2.2 millio millionL nL )** )**  Two Two pos positiv itivee )**s. )**s. b. !"  K2.2 millionL )**  10J. c. !"  K12.2 mill ionL )**  Two positive )**s. d. !" !"  K12 K12. .2 2 milli million onLL )** )**  10J. 10J. e. one one of the the abo above ve.. (12-) NP. a%# IRR A%s/"*: Diff: ! . A compan compan# # is anal#4 anal#4ing ing two mutuall# mutuall# eclus eclusive ive projec projects, ts, = and and >, whos whosee cash cash flows flows are sho shown wn belowH belowH

6

ears ears = >

-

G1,1-G1,1--

1

2

$

8-- $//- $-- /--

' 16/-

The compan#s cost of capital capital is 12 percent, and it can get get an unlimited amount of capital at that cost. @hat is the regular IRR %not :)**& of the better project project %
1$.-8J 12.--J 1.'0J 1$.66J 12./$J

(12-) NP. 5*&fil"s . The The fol follow lowin ing g cas cash h flow flowss are are esti estima mate ted d for for two two mutu mutual all# l# ec eclu lusi sive ve proje project ctsH sH

A%s/"*: Diff: !

66

ear 1 2 $ '

!roject A 7ash Flow GK1--,--0-,--'-,--2-,--1-,---

!roject B 7ash Flow GK11-,--2-,--'-,--'-,--/-,---

@hen is !roject B more lucrative lucrative than !roject A %That is, over what range of costs of capital %r& does !roject B have a higher !" than !roject A& A& %7hoose the best answer.& answer.&


Page 23

a. b. c. d. e.

For all values values of r less less than than .2/J .2/J.. !roject B is alwa#s more profitable than !roject A. !rojec !rojectt A is alwa# alwa#ss more prof profitab itable le than than !rojec !rojectt B. For all values values of r less less than than 0./J 0./J.. For all values values of r greate greaterr than than 0./ 0./J. J.

(12-) C*&ss&4"* *at" . :c7a :c7arv rver er )nc. nc. is cons conside ideri ring ng the the foll follow owing ing mutua mutuall# ll# ecl eclus usiv ivee pro proje ject ctsH sH

A%s/"*: Diff: !

68

ear 1 2 $ '

!roject A 7ash Flow GK/,--2-6-$,--/,---

!roject B 7ash Flow GK/,--$,--$,--6- 2- -

At what cost of capital will the net present value of the two projects be the same %That is, what is the McrossoverN rate& a. b. c. d. e.

1/.06J 10.1/J 10.2/J 1.2J 1.6-J

(12-) C*&ss&4"* *at" A%s/"*: Diff: ! . :artin :artin Fillmor Fillmoree is is a big footba football ll star star who has been been off offere ered d contr contrac acts ts b# b# two two diff differe erent nt team teams. s. The pa#men pa#ments ts %in millions of dollars& he receives under the two contracts are listed belowH

8-

ear 1 2 $ '

Team A 7ash Flow 7ash Flow K6.'.'.'.'.'.6.'.6.-

Team B K2./

Fillmore is committed to accepting the contract which provides him with the highest net present value %!"&. At what discount rate would he be indifferent between the two contracts a. b. c. d. e.

Page 24

1-.6/J 11.$/J 10.'8J 18.0J 21.-$J


(12-) C*&ss&4"* *at" . =hel =helb# b# )nc. )nc. is is con consi side deri ring ng two two pro proje ject ctss whic which h hav havee the the fol follo lowin wing g cas cash h flo flows wsHH !roject 1 !roject 2 ear 7ash Flow 7ash Flow GK2,--GK1,8-1 /-1,1-2 -8-$ 6-6-' 1,--0-/ 1,1-'--

A%s/"*: Diff: !

81

At what cost of capital would the two projects have the same net present value a. b. c. d. e.

'.$J /.6/J /.86J 0.'-J 0.-J

(12-) C*&ss&4"* *at" A%s/"*: Diff: ! . Qac5so Qac5son n Qets Qets is is consi consider dering ing two mutuall mutuall# # eclu eclusiv sivee proje projects cts.. The The proje projects cts have have the the follow following ing cash cash flows flowsHH

82

ear 1 2 $ '

!roject A 7ash Flow GK1-,--1,--2,--0,--0,---

!roject B 7ash Flow GK6,--,--1,--1,--1,---

At what cost of capital do the two projects have the same net present value %That is, what is the crossover rate& a. b. c. d. e.

11.2-J 12.20J 12.6'J 1$.-$J 1'.1/J

(12-) C*&ss&4"* *at" A%s/"*: Diff: ! . :idwa# :idwa# :otors :otors is conside considerin ring g two two mutu mutuall# all# eclus eclusive ive projec projects, ts, !rojec !rojectt A and !rojec !rojectt B. B. The projec projects ts are are of equal ris5 and have the following cash flowsH

8$

ear 1 2 $ '

!roject A 7ash Flows GK1--,--'-,--2/,---,--'-,---


!roject B 7ash Flows GK1--,--$-,--1/,--6-,--//,---

Page 25

At what @A77 @A77 would the two projects have the same !" a. b. c. d. e.

1-.$$J 1$.8/J 11.21J 2/.11J 1'.'8J

(12-) C*&ss&4"* *at" A%s/"*: Diff: ! . *obin *obinso son n *obo *obotic ticss is cons conside ideri ring ng two two mutua mutuall# ll# ec eclu lusi sive ve proj projec ects, ts, !ro !roje ject ct A and and !roje !roject ct B. B. The The proj projec ects ts have the following cash flowsH

8'

ear 1 2 $ ' /

!roject A 7ash Flow GK2-2$'/0-

!roject B 7ash Flow GK$-80/'-

At what cost of capital would the two projects have the same net present value %!"& a. b. c. d. e.

12.08J 6.'/J 1-.$2J 8.$2J G'.80J

(12-8) !&#ifi"# IRR A%s/"*: Diff: ! . 7api 7apitol tol 7it# 7it# Tran Transf sfer er 7om 7ompa pan# n# is is cons conside ideri ring ng bui build lding ing a new new termin terminal al in in =alt =alt >a5 >a5ee 7it# 7it#. )f the the comp compan an# # goes ahead with the project, it must spend K1 million immediatel# %at t  -& and another K1 million at the end of ea earr 1 %t  1&. )t will then receive net cash flows flows of K-./ million at the end of ears ears 2 G /, and it epects to sell the propert# and net K1 million at the end of ear ear 0. All cash inflows and outflows are after taes. The compan#s compan#s cost of capital is 12 percent, percent, and it uses the modified modified )** criterion for capital capital budgeting decisions. @hat is the projects modified )** %:)**&

8/

a. b. c. d. e.

11.8J 12.-J 11.'J 11./J 11.J

(12-8) !&#ifi"# IRR A%s/"*: Diff: ! .
80

Page 26


a. b. c. d. e.

./J 6.28J 8.61J 11.'/J 12.$$J

(12-8) !&#ifi"# IRR A%s/"*: Diff: ! . :art :artin in :anu :anufa fact ctur urer erss is cons conside ideri ring ng a five fiveG# G#ea earr inves investme tment nt whic which h costs costs K1-K1--,-,---. -. The The inves investme tment nt will will produce cash flows of K2/,--- each #ear for the first two #ears %t  1 and t  2&, K/-,--- a #ear for each of the remaining three #ears %t  $, t  ', and t  /&. The compan# has a cost of capital capital of 12 percent. @hat is the :)** of the investment

8

a. b. c. d. e.

12.1-J 1'.$$J 10.--J 16.2/J 18.'/J

(12-8) !&#ifi"# IRR A%s/"*: Diff: ! . Ache Acheso son n Alum Alumin inum um is cons consid ider erin ing g a proje project ct with with the the follo followin wing g cash cash flow flows. s. 7ash 7ash flow flowss in pare parent nthe hese sess denote negative cash flows.

86

ear 1 2 $ '

7ash Flow %K2--,---& 12/,--1'-,--%/-,---& 1--,---

AchesonIs @A77 @A77 is 1- percent. @hat is the projectIs modified internal rate of return %:)**& a. b. c. d. e.

1.8/J 10.$6J 1'.8-J 1/.2$J 12.60J

(12-8) !&#ifi"# IRR A%s/"*: Diff: ! . Belang Belanger er 7onstr 7onstruct uction ion is cons conside iderin ring g the the followi following ng projec project. t. The projec projectt has has an an upGf upGfron rontt cost cost and will also also generate the following subsequent cash flowsH

88

t1 t2 t$

K'-/-2--

The projectIs pa#bac5 pa#bac5 is 1./ #ears, and it has a cost of capital of 1- percent. @hat is the projectIs modified internal rate of return %:)**& a. b. c. d. e.

1-.--J 18.0/J 21./'J 2$.62J 1'./J


Page 27

(12-8) !IRR a%# IRR A%s/"*: Diff: ! . Qone Qoness 7ompa 7ompan# n#s s new new truc5 truc5 has has a cost cost of K2-,K2-,----,, and it will will prod produc ucee endGo endGofG fG#e #ear ar net net cash cash inflow inflowss of K,--- per #ear for / #ears. The cost of capital for an averageGris5 project li5e the truc5 is 6 percent. @hat is the sum of the projects )** and its :)**

1--

a. b. c. d. e.

1/.'6J 16./J 20.11J $'.2$J $./8J

(12-8) !IRR a%# IRR A%s/"*: Diff: ! . Florid Floridaa !hosph !hosphate ate is consi consider dering ing a projec projectt which which involve involvess op openi ening ng a new new mine mine at at a cost cost of K1K1-,-,---,-,---- at at t  -. The project project is epected to have operating operating cash flows of K/,---,--K/,---,--- at the end of each of the net ' #ears.
1-1

a. b. c. d. e.

-.--J -./1J $.'-J 8.0/J 1$.6J

(12-11) R"5lac"$"%t cai% A%s/"*: Diff: ! . Dohe Dohert# rt# )nd )ndus ustr trie iess wants wants to inv inves estt in a new new compu compute terr s#ste s#stem. m. The The comp compan an# # onl# onl# want wantss to inve invest st in one one s#stem, and has narrowed the choice down to =#stem A and =#stem B.

1-2

=#stem A requires an upGfront cost of K1--,--- and then generates positive afterGta cash flows of K0-,--at the end of each of the net two #ears. The s#stem can be replaced ever# two #ears with the cash inflows and outflows remaining the same. =#stem B also requires an upGfront cost of K1--,--- and then generates positive afterGta cash flows of K'6,--- at the end of each each of the net three #ears. #ears. =#stem B can be replaced ever# ever# three #ears, but each each time the s#stem is replaced, both the cash inflows and outflows increase b# 1- percent. The compan# needs a computer s#stem for the si #ears, after which time the current owners plan on retiring and liquidating the firm. The compan#s compan#s cost of capital is 11 percent. percent. @hat is the !" !" %on a siG #ear etended basis& of the s#stem which creates the most value to the compan# a. b. c. d. e.

Page 2

K 1,286.$K 22,0$'. K $1,211./2 K $6,/2$.'$ K1-$,-0/.62


(12-11) R"5lac"$"%t cai% A%s/"*: Diff: ! . Qohnso Qoh nson n Qets Qets is is consi consider dering ing two mutuall# mutuall# eclus eclusive ive mach machine ines. s. :achin :achinee A has an upGf upGfron rontt cost cost of of K1--,K1--,---%7F-  G1--,---&, and produces positive afterGta cash inflows of K'-,--- a #ear at the end of each of the net si #ears.

1-$

:achine B has an upGfront cost of K/-,---%7F -  G/-,---& and produces afterGta cash inflows of K$-,--a #ear at the end of the net three #ears. After three #ears, #ears, machine B can be replaced at a cost of K//,--%paid at t  $&. The replacement machine will produce afterGta afterGta cash inflows of K$2,--- a #ear for three #ears %inflows received at t  ', /, and 0&. The compan#Is cost cost of capital is 1-./ percent. @hat is the net present value %on a siG#ear etended basis& of the most profitable machine a. b. c. d. e.

K2$,8/K'1,0/0 K/0,2$6 K02,'/0 K1,06

(12-11) R"5lac"$"%t cai% A%s/"*: Diff: ! . A smal smalll manu manufa fact ctur urer er is cons consid ider erin ing g two alter alterna nati tive ve mach machin ines es.. :ach :achin inee A cost costss K1 mill millio ion, n, has has an epected life of / #ears, and generates afterGta cash flows of K$/-,--- per #ear. #ear. At the end of / #ears, the salvage value of the original machine is 4ero, but the compan# will be able to purchase another :achine A at a cost of K1.2 million. The second :achine A will generate afterGta cash flows of K$/,--K$/,--- a #ear for another / #ears at which time its salvage value will again be 4ero. Alternativel#, the compan# can bu# :achine B at a cost of K1./ million toda#. :achine B will produce afterGta cash flows of K'--,--- a #ear #ear for ten #ears, and after ten #ears #ears it will have an afterGta salvage value of K1--,---. Assume that the cost of capital capital is 12 percent. percent. )f the compan# compan# chooses chooses the machine which which adds the most value to the firm, b# how much will the compan#s value increase

1-'

a. b. c. d. e.

K$',6-2.-K'/1,/.21 K0$$,'61.18 K82,26 ,260./' ./' K611,$/.00

(12-11) R"5lac"$"%t Cai% A%s/"*: Diff: ! . Ring *acing *acing 7ompan 7ompan# # %R*7& %R*7& is cons conside iderin ring g which which of two two mutu mutuall all# # eclu eclusive sive engine engine deve develop lopmen mentt proje projects cts to pursue. Rings *! design has an epected life of ' #ears #ears and projected cash inflows are K$.0 million at the end of each of the first two #ears and K1.6 million in each of the net two #ears. Rings *!B design is more fleible fleible and has an eightG#ea eightG#earr life. The projected projected endGofG#ea endGofG#earr flows from the *!B design are K2.' million in each of the first two #ears #ears and K2.- million in each of the net net si #ears. Both projects require an initial investment of K/.' million, and Rings cost of capital is 12 percent. percent. Frequent changes in racing racing rules and engine technolog# ma5e engine development ris5#, but Ring feels that the basic designs can be refined and modified. Thus, Ring often assumes that continuous continuous replacements can be made as a projects life ends. @hat is the net present value %on an eightG#ear etended basis& of the project with the most value to the compan#

1-/

a. b. c. d. e.

K $.1-8 mil millio lion K 1.80 million K /.-6/ mil millio lion K /. /.211 mi millio lion K 0.216 mil millio lion


Page 2!

(12-11) R"5lac"$"%t Cai% A%s/"*: Diff: ! . :ills :ills 7orp 7orp.. is consid consideri ering ng adop adopting ting one of two machin machines. es. :achine :achine A requir requires es an an upGf upGfron rontt epen ependitu diture re at at t  - of K'/-,---. K'/-,---. :achine :achine A has has an epected life of two #ears, and will generate generate positive afterGta afterGta cash flows of K$/-,--- per #ear %all cash flows are reali4ed reali4ed at the end of the #ear&. At the end of two #ears, the machine will have 4ero salvage salvage value. Ever# two #ears the compan# can purchase a replacement machine with identical cash flows.

1-0

Alternativel#, :achine B requires an ependiture of K1 million at t  -. :achine B has an epected life of four #ears, and will generate positive afterGta cash flows of K$/-,--- per #ear %all cash flows are reali4ed at #ear end&. At the end of four #ears, :achine B will have an afterGta salvage value of K1--,---. The cost of capital is 1- percent. @hat is the net present value %on an etended fourG#ear fourG#ear life& of the better machine a. b. c. d. e.

K1/,'$6 K1,/' K26,//2 K$//,/-6 K/--,---

(C&$5-) !utually "3clusi4" 5*&6"cts A%s/"*: Diff: ! . Two projec projects ts being being con consi side dere red d b# a firm firm are are mutual mutuall# l# ecl eclus usiv ivee and have have the the follo followin wing g proje project cted ed cash cash flowsH

1-

!roject A 7ash Flow %K1--,---& $8,/-$8,/-$8,/--

ear 1 2 $

!roject B 7ash Flow %K1--,---& 1$$,---

Based only on the information given, which of the two projects would be preferred, and wh# a. b. c. d.

!rojec !rojectt A, bec becaus ausee it has a shor shorter ter pa# pa#bac bac5 5 period period.. !roject B, because it has a higher )**. )ndif )ndiffe feren rent, t, becaus becausee the projec projects ts have have equal equal )**s. )**s. )nclude )nclude both in the capital capital budget, budget, since since the sum sum of the cash cash inflows inflows eceeds eceeds the the initial investme investment nt in both cases. e. 7hoose 7hoose neithe neither, r, sinc sincee their their !"s !"s are are negati negative. ve.

Tough: (12-2) NP. . *etu *eturn rnss on the the mar mar5e 5ett and and 7omp 7ompan an# # s s stoc stoc5 5 duri during ng the the las lastt $ #ear #earss are are show shown n belo belowH wH

A%s/"*: Diff: T

1-6

ear ear 2-- 2--6 2--8

:ar5et G2'J 122

7ompan# 7ompan #  G22J 1$ $0

The ris5Gfree rate is / percent, and the required return on the mar5et is 11 percent. ou are considering a

Page 3"


lowGris5 project whose mar5et beta is -./ less than the compan#s overall corporate beta. ou ou finance onl# with equit#, equit#, all of which comes from from retained earnings. earnings. The project project has a cost of K/-- million, and it is epected to provide cash flows of K1-- million per #ear at the end of ears 1 through / and then K/million per #ear at the end of ears ears 0 through 1-. @hat is the projects !" %in millions of dollars& a. b. c. d. e.

K .1K 8.20 K1-.'2 K12.1K1/./

(12-2) P. &f cas fl&/s A%s/"*: Diff: T . After After gett getting ing her her degr degree ee in mar mar5et 5eting ing and and wor5 wor5ing ing for for / #ear #earss for a large large depa departm rtment ent stor store, e, =all# =all# star started ted her her own specialt# shop in a regional mall. =all#s current lease calls for pa#ments of K1,--- at the end of each each month for the net 0- months. ow the landlord offers =all# a new /G#ear /G#ear lease which calls for 4ero rent for 0 months, then rental pa#ments of K1,-/- at the end of each month for the net /' months. =all#s cost of capital is 11 percent. percent. B# what absolute dollar dollar amount would accepting accepting the new lease change =all#s =all#s theoretical net worth %
1-8

a. b. c. d. e.

K2,61-.-8 K$,2'$.2' K$,6-$.-0 K',288.6 K',061.0

(12-) NP. 5*&fil"s A%s/"*: Diff: T . As the direc directo torr of capi capita tall budg budget etin ing g for for *ale *aleig igh? h?Du Durh rham am 7ompa 7ompan# n#,, #ou are are eval evalua uati ting ng two mutua mutuall ll# # eclusive projects with the following net cash flowsH

11-

1 2 $ '

GK1-/'$1-

ear ear GK1-1$'0-

!roject  !roject O 7ash Flow 7ash Flow

)s there a crossover point in the relevant part of the !" profile graph %the northeast, or upper right, quadrant& a. b. c. d. e.

o. es, es, at r  J. es, at r  8J. es, at r  11J. es, at r  1$J.


Page 31

(12-8) !IRR a%# NP. A%s/"*: Diff: T . our comp compan an# # is consi conside deri ring ng two mutua mutuall# ll# ecl eclus usiv ivee proje project cts, s,  and , , whos whosee costs costs and and cash cash flows flows are shown belowH

111

!roject  1 2 $ '

GK2,--2-0-6-1,'--

!roject  ear 7ash 7ash Flow low 7ash 7ash Flow Flow GK2,--2,--2-1-/

The The proj projec ects ts are are equa equall# ll# ris5# ris5#, and and the the firm firms s cost cost of capita capitall is 12 percen percent. t. ou must must ma5e ma5e a recommenda recommendation, tion, and #ou must base base it on the modified )** )** %:)**&. %:)**&. @hat is the :)** :)** of the better project a. b. c. d. e.

12.--J 11.'0J 1$./8J 12.68J 1/.$J

(12-8) !&#ifi"# IRR A%s/"*: Diff: T . :oor :o orad adia ian n 7orpor 7orporat atio ion n estima estimate tess that its its cost cost of capita capitall is 11 perc percen ent. t. The comp compan an# # is conside consideri ring ng two mutuall# eclusive projects whose afterGta cash flows are as followsH

112

!roject =

!roject >

ear ear 7ash Flow 7ash Flow GK$,--GK8,--1 2,/-G1,--2 1,/-/,--$ 1,/-/,--' G/-/,--@hat is the modified internal rate of return %:)**& of the project with the highest !" a. b. c. d. e.

Page 32

11.68J 1$.00J 10.-1J 16.2/J 2-.12J


(12-8) !&#ifi"# IRR . A comp compan an# # is is con consi side deri ring ng a pro proje ject ct with with the the follo followi wing ng cash cash flow flowsH sH

A%s/"*: Diff: T

11$

ear 1 2 $ '

7ash flow GK1--,--/-,--/-,--/-,--G1-,---

The projectIs projectIs cost cost of capital is estimated to be 1- percent. percent. @hat is the modified modified internal rate of return return %:)**& a. b. c. d. e.

11.2/J 11./0J 1$.26J 1'.2/J 2-.$'J

(12-8) !&#ifi"# IRR . Qavi Qavier er 7orpo 7orpora ratio tion n is cons consid ider ering ing a pro proje ject ct with with the the follo followin wing g cas cash h flow flowsH sH

A%s/"*: Diff: T

11'

ear 1 2 $ '

7ash Flow GK1$,--12,--6,--,--G1,/--

The firmIs cost of capital capital is 11 percent. @hat is the projectIs modified internal internal rate of return %:)**& a. b. c. d. e.

10.62J 21.06J 2$.6J 2'.8-J 2/.8$J


Page 33

(12-8) !&#ifi"# IRR A%s/"*: Diff: T . Ta#lor #lor Te Techno chnolog logie iess has a targ target et capi capita tall struc structu ture re whic which h is '- perc percen entt debt debt and 00- perce percent nt equi equit# t#.. The The equit# will be financed financed with retained earnings. earnings. The compan#I compan#Iss bonds have a #ield to maturit# of 1 percent. The compan#Is stoc5 stoc5 has a beta  1.1. The ris5Gfree rate is 0 percent, the mar5et ris5 premium is / percent, and the ta rate is $- percent. The compan# is considering a project with the following cash flowsH

11/

ear 1 2 $ '

!roject A 7ash Flow GK/-,--$/,--'$,--0-,--G'-,---

@hat is the projectIs modified internal rate of return %:)**& a. b. c. d. e.

0.0J 8.20J 1-.6J 10.1'J 2-./2J

(12-8) !&#ifi"# IRR . 7onr 7onrad ad 7or 7orp. p. has has an inve invest stme ment nt pro proje ject ct with with the the fol follow lowin ing g cas cash h flow flowsH sH

A%s/"*: Diff: T

110

ear 1 2 $ ' /

!roject 7ash Flow GK1,--2- G$-8- G-0- -

The compan#Is @A77 @A77 is 12 percent. @hat is the projectIs modified internal rate of return %:)**& a. b. c. d. e.

Page 34

2.0$J $.2-J $.8/J /.06J 0.6$J


(12-8) !&#ifi"# IRR . =immo =immons ns =hoe =hoess is cons consid ider erin ing g a pro proje ject ct with with the the follo followin wing g cas cash h flow flowsH sH

A%s/"*: Diff: T

11

ear 1 2 $ '

!roject 7ash Flow G K - ' -G 2-0 -/ --

=immonsI @A77 @A77 is 1- percent. @hat is the projectIs modified internal rate of return %:)**& a. b. c. d. e.

1.1-J 16.20J 2/.26J 26.8$J 28./2J


Page 35

CHAPTER 12 ANS
Page 36

1

(12 2) PV of cash flows


Answer: b

Diff: E

1.

(12.2) PV of cash flows

Answer: b

Diff: E

2.

(12.2) NPV

Answer: b

Diff: E

3.

(12.3) IRR

Answer: a

Diff: E

4.

(12.3) IRR

Answer: a

Diff: E

5.

(12.3) IRR

Answer: b

Diff: E

6.

(12.4) IRR and NPV

Answer: b

Diff: E

7.

(12.4) Ranin! "e#hods

Answer: b

Diff: E

8.

(12.4) $%#%all& e'cl%sie ro*ec#s

Answer: a

Diff: E

9.

(12.+) $%l#ile IRRs

Answer: b

Diff: E

10.

(12.,) $odified IRR

Answer: b

Diff: E

11.

(12.,) $odified IRR

Answer: b

Diff: E

12.

(12.,) Reines#"en# ra#e ass%"#ion

Answer: a

Diff: E

13.

(12.-) Pa&bac eriod

Answer: a

Diff: E

14.

(12.11) Relace"en# chain

Answer: b

Di Diff: E

15.

(12.12) ai#al b%d!e#

Answer: b

Diff: E

16.

(12.2) NPV

Answer: b

Diff: $

17.

(12.1) NPV

Answer: a

Diff: $

18.


Answer: b

Diff: $

19.

(12.4) $%#%all& e'cl%sie ro*ec#s

Answer: b

Diff: $

20.

(12.4) IRR and NPV Answer: b Diff: $ We do not know if we are to the right or left of the crossover point. herefore! the "#$ of % &a' (e less than the "#$ of ).

21 .

(12.4) NPV ers%s IRR

Answer: b

Diff: $

22.

(12.4) NPV ers%s IRR

Answer: b

Diff: $

23.

(12.4) NPV rofile #ro*ect % &a' have a negative "#$ if r + ,--.

Answer: b

Diff: $

24.

(12.,) Reines#"en# ra#e ass%"#ion Answer: a Diff: $ ,f the cost of capital happens to (e e/al to the ,--! this condition can eist.

25 .

(12.1/) 0"all b%siness

Answer: a

Diff: $

26.


Answer: b

Di Diff: $

27.

(12.11) o""on life co"arisons

Answer: a

Diff: $

28.


Answer: a

Diff: $

29.

(12.1) IRR Answer: b Diff: E he correct state&ent is is ( the other other state&ents state&ents are false. false. ince #ro*ect #ro*ect s ,-- is 15! at a W of 15 "#$   0 however! #ro*ect  wo/ld still

have a positive positive "#$. "#$. iven the infor&ation in a! we cant concl/de concl/de which pro*ects "#$ is going going to (e greater. greater. ince we are are given no no details a(o/t a(o/t each each pro*ec pro*ects ts cash cash flows flows we cannot cannot concl/ concl/de de an'thi an'thing ng a(o/t a(o/t pa'(ac pa'(ack. k. :inall'! ,-- is independent of the disco/nt rate! i.e.! ,-- sta's the sa&e no &atter what the W is. 30.

(12.4) Ranin! conflic#s

Answer: a

Diff: E

31.

(12.4) NPV rofiles

Answer: b

Diff: E

32.

(12.4) NPV and IRR Answer: a Diff: E tate&ent a is correct the other other state&ents state&ents are false. ,f the pro*ects are &/t/all' ecl/sive! then pro*ect  &a' have a higher "#$ even tho/gh #ro*ect #ro*ect  has a higher higher ,--. ,--. ,-- is calc/l calc/lated ated ass/& ass/&ing ing cash cash flows flows are reinvested at the ,--! not the cost of capital.

33.

(12.4) NPV and IRR Answer: a Diff: E tate&ent a is tr/e pro*ects with ,--s greater than the cost of capital will have a positive "#$. tate&ent ( is false false (eca/se (eca/se 'o/ know nothing nothing a(o/t a(o/t the relativ relative e &agnit/d &agnit/des es of the pro*ects pro*ects. . tate& tate&ent ent c is false false (eca/se (eca/se the ,-,-- is independ independent ent of the cost cost of capital. capital. herefor herefore! e! the correct choice is state&ent a.

34.


Answer: e

Diff: E

35. 36 .

(12.1/) Pos#a%di#

Answer: e

Diff: E

37.

(o".) NPV IRR and $IRR Answer: b Di Diff: E tate&ent ( is correct the other other state&ents state&ents are incorrect. tate&ent a is incorrect incorrect if the the "#$ + 0! then the the ret/rn &/st (e + 12. tate&ent c is incorrect if "#$ + 0! then ;,-- + W.

38.

(o".) Ranin! "e#hods Answer: b Diff: E  pro*ect
39 .

(12.12) Pro*ec# selec#ion Answer: e Diff: E :or &/t/all' ecl/sive ecl/sive pro*ects pro*ects! ! alwa's alwa's take the one with the greatest greatest "#$.

(12.2) Pro*ec# selec#ion his his is the the onl' onl' pro* pro*ec ect t with with eceeds the cost of capital.

eith either er

a

posi positi tive ve

Answer: a "#$ "#$ or an

Diff: $ ,-,-- whic which h

40.

(12.3) IRR

Answer: e

Diff: $

41.


Answer: b

Diff: $

42.


Answer: a

Diff: $

43.

(12.4) NPV and IRR

Answer: c

Diff: $

44.

(12.4) NPV and IRR tate&ent a is the incorrect incorrect state&ent. state&ent. than the cost of capital.

45.

(12.4) Ranin! "e#hods Answer: b Diff: $ his state&ent state&ent reflects reflects eactl' the differen difference ce (etween (etween the "#$ and ,-ðods.

46.


Answer: a Diff: $ "#$ is positive positive if ,-- is greater

Answer: e

Diff: $

oth state&ents a and c are correct therefore! state&ent e is the correct choice. choice. =/e to reinve reinvest&e st&ent nt rate ass/&p ass/&ption tions! s! "#$ and ,-,-- can lead lead to conflicts however! there will (e no conflict (etween "#$ and ;,-- if the pro*ec pro*ects ts are e/al e/al in si>e si>e ?which ?which is one of the ass/&pt ass/&ption ions s in this this /estion@. 47.

48 .

(12.4) $iscellaneo%s conce#s Answer: e Diff: $ tate&ent e is correct correct the the other state&ents are false. false. ,-- can lead to conflicting decisions decisions with "#$ even with nor&al cash flows if the pro*ects are &/t/al &/t/all' l' ecl/si ecl/sive. ve. ash ash o/tflo o/tflows ws are disco/ disco/nte nted d at the cost cost of capital with the ;,-- ðod! while cash inflows are co&po/nded at the cost of capit capital. al. onflict onflicts s (etween (etween "#$ and and ,-- arise arise when the the cost cost of capital is is (elow the the crossover crossover point. he disco/nted disco/nted pa'(ack pa'(ack ðod does correct the pro(le& of ignoring the ti&e val/e of &one'! (/t it still does not acco/nt for cash flows (e'ond the pa'(ack period. (12.4) $iscellaneo%s conce#s Answer: a D Di iff: $ tate& tate&ent ent a is correct correct  the other other state&e state&ents nts are are false. false. ketch ketch the the prof profil iles es. . :ro& :ro& the the inf infor or&a &ati tion on giv given en! ! = has has the the hig highe her r ,--. ,--. he he pro*ects scale cannot cannot (e deter&ined fro& the the infor&ation infor&ation given. given. s s "#$ declines &ore rapidl' with an increase in rates! this i&plies that &ore &ore of the cash cash flows flows are co&ing co&ing late later r on. o  wo/ld wo/ld have a slower slower pa'(ack than =.

49.

(12.,) $odified IRR

50.

(o".) $iscellaneo%s conce#s Answer: e Diff: $ tate& tate&ent ents s a and c are corre correct ct theref therefore ore! ! state& state&ent ent e is the correc correct t choice. he disco/nted disco/nted pa'(ack pa'(ack ðod ðod still ignores ignores cash cash flows after the pa'(ack period.

51 .

52 . 53.

54 .

55 .

56 . 57.

Answer: e

Diff: $

(o".) $iscellaneo%s conce#s Answer: a Diff: $ tate&ent a is correct the other state&ents state&ents are false. ;/ltiple ,--s can occ/r occ/r onl' for pro*ect pro*ects s with nonnor&a nonnor&al l cash flows. flows. ;/t/all' ;/t/all' ecl/s ecl/sive ive pro*ects i&pl' that that onl' one pro*ect pro*ect sho/ld sho/ld (e chosen. chosen. he pro*ect pro*ect with the highest "#$ sho/ld (e chosen. (o".) NPV IRR and $IRR

Answer: b

D Di iff: $

(o".) NPV IRR and a&bac Answer: e Diff: $ tate&ent e is correct the other state&ents are incorrect. tate&ent a is incorrec incorrect t the two pro*ects pro*ects< < "#$ profiles profiles co/ld cross! cross! conse/e conse/entl' ntl'! ! a higher ,-,-- doesn
(o".) NPV IRR and $IRR Answer: a D Di iff: $ he correct correct answer is a the the other state&ents are false. he ,-- is the disco/ disco/nt nt rate rate at which which a pro*ec pro*ectero. >ero. ,f a pro*ect pro*ecte. "#$ does not s/ffer fro& the &/ltiple ,-- pro(le&. (12.4) NPV rofiles

Answer: b

Diff: 

(12.4) hoosin! a"on! "%#%all& e'cl%sie ro*ec#s Answer: c Diff:  =raw o/t the the "#$ profiles profiles of these these two pro*ects. pro*ects. s s "#$ "#$ declines &ore rapidl' with an increase in disco/nt rates! this i&plies that &ore of the

cash flows are co&ing later later on. than #ro*ect .

herefore! #ro*ect  has has a faster pa'(ack pa'(ack

58.

(12.4) NPV IRR and $IRR

59.

(o".) NPV IRR and $IRR Answer: a Di Diff:  tate&ent a is tr/e. o see this! this! sketch o/t a "#$ profile for for a nor&al! nor&al! independent pro*ect! which &eans that onl' one "#$ profile will appear on the graph. ,f W A ,--! ,--! then then ,-- sa's sa's accept. /t in in that that case! case! "#$ + 0! so so "#$ "#$ will will also also sa' accept accept. . tate& tate&ent ent d is false false. . Bere Bere is the reasoningC 1. :or the "#$ profile profiles s to cross! then then one pro*ect pro*ect &/st have have a higher "#$ at r  0 than the other pro*ect! i.e.! their vertical ais intercepts will (e different. 2.  second condit condition ion for "#$ profile profiles s to cross is that one have have a higher ,-- than the other. 3. he third condition condition necessar' necessar' for profiles profiles to cross cross is that the pro*ect with the higher "#$ at r  0 will have the lower ,--. ,--. Dne can sketch o/t two "#$ profiles on a graph to see that these three conditions are indeed re/ired. 4. he pro*e pro*ect ct with with the higher higher "#$ "#$ at r  0 &/st &/st have more cash inflows! (eca/se it has the higher "#$ when cash flows are not disco/nted! which which is the sit/ation if r  0. 5. ,f the pro*ect pro*ect with &ore total total cash inflow inflows s also also had had its cash cash flows flows co&e in earlier! it wo/ld do&inate the other pro*ectEEits "#$ wo/ld (e higher at all disco/nt rates! and its ,-- wo/ld also (e higher! so the profiles wo/ld wo/ld not cross. he onl' wa' the profiles can cross is for the pro*ec pro*ect t with with &ore &ore total total cash cash inflow inflows s to get a relati relativel vel' ' high high percentage of those inflows in distant 'ears! so that their #$s are low when when disco/ disco/nt nted ed at high high rates rates. . ;ost ;ost st/den st/dents ts eithe either r gras grasp p this this int/itivel' or else */st g/ess at the /estionF

60.

(12.2) NPV i&e lineC 0

Answer: a Project X (In thousands) 1 2 r  15

:% E100

"#$ 

Answer: c

r  15 50

43.478 30.246 19.725 5.718 E0.833  EG833

40

26.301 34.305 "#$H 

4 )ears

30

10

r  15 r  15

r  15 10

8.696 22.684

Diff: E

r  15

Project Z (In thousands) 0 1 r  15

:% E100

3

D Di iff: 

2

3

30

40

4 )ears 60

r  15 r  15 r  15

E8.014  EG8!014.

t a cost of capital of 15! (oth pro*ects have negative "#$s and! th/s! (oth wo/ld (e re*ected. "/&erical sol/tionC (In thousands) "#$%  E100 I 50?1J1.15@ I 40?1J1.15 2@ I 30?1J1.15 3@ I 10?1J1.15 4@  E100 I 50?0.8696@ I 40?0.7561@ I 30?0.6575@ I 10?0.5718@  E0.833  EG833. "#$H  E100 I 10?1J1.15@ I 30?1J1.15 2@ I 40?1J1.15 3@ I 60?1J1.15 4@

 E100 I 10?0.8696@ I 30?0.7561@ I 40?0.6575@ I 60?0.5718@  E8.013  EG8!013. :inancial calc/lator sol/tionC (In thousands) Project X ,np/tsC : 0  E100 : 1  50 : 2  40 : 3  30 :4  10 ,  15. D/tp/tC "#$%  E0.833  EG833. Project Z ,np/tsC : 0  E100 : 1  10 : 2  30 : 3  40 :4  60 ,  15. D/tp/tC "#$H  E8.014  EG8!014. 61.

(12.2) NPV i&e lineC 0 1 r  10 : E50!000 "#$  K : E50!000 "#$  K

Answer: a 2

15!625

3

15!625

4

15!625

Diff: E

5 )ears

15!625

15!625 99!500

"/&erical sol/tionC "#$  G15!625L?1J0.10@E?1J?0. G15!625L?1J0.10@E?1J?0.10M?1I0.10@ 10M?1I0.10@ 5@N G50!000  G15!625?3.7908@ E G50!000  G59!231.25 E G50!000  G9!231.25. "#$  G99!500?1J1.10 G99!500?1J1.10 5@ E G50!000  G99!500?0.6209@ E G50!000  G61!779.55 E G50!000  G11!779.55. "#$ + "#$  G11!779.55 + G9!231.25 hoose #ro*ect . :inancial calc/lator sol/tionC Project A ,np/tsC "  5 ,  10 #;  15!625. D/tp/tC #$  E59!231.04. "#$  G59!231.04 E G50!000  G9!231.04. Project B ,np/tsC "  5 ,  10 :$  99!500. D/tp/tC #$  E61!781.67. "#$  G61!781.67 E G50!000  G11!781.67. Alternate method by cash flows: Project A ,np/tsC : 0  E50!000 : 1  15!625 " *  5 ,  10. D/tp/tC "#$  G9!231.04. Project B ,np/tsC : 0  E50!000 : 1  0 "*  4 : 2  99!500 ,  10. D/tp/tC "#$  G11!781.67. 62 .

(12.-) Pa&bac eriod i&e lineC ?In thousands@

Answer: b

Diff: E

0

1 2 3 4 5 6 7 8 9 10 )rs r  10 OOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO :s E150 30 30 30 30 35 35 35 35 35 40 /&/lative :s E150 E120 E90 E60 E30 5

Psin Psing g the the even even cash cash flow flow dist distri ri(/ (/ti tion on ass/ ass/&p &pti tion on! ! the the pro* pro*ec ect t co&pletel' recover initial invest&ent invest&ent after 30J35  0.86 of )ear 5C #a'(ack  4 I 63 .

30 35

 4.86 'ears.

(12.2) NPV i&e lineC ?,n tho/sands@ 0

r  14

#$  K

will will

Answer: b

1

2

3

4

5

6

7

8

9

5

5

5

5

5

3

3

3

2

Diff: $ 10 )rs.

2

"/&erical sol/tionC #$  G5!000L?1J0.14@E?1J?0.1 G5!000L?1J0.14@E?1J?0.14M?1I0.14@ 4M?1I0.14@ 5 I G3!000L?1J0.14@E?1J?0.1 G3!000L?1J0.14@E?1J?0.14M?1I0.14@ 4M?1I0.14@ 3 ?1J1.145@ I G2!000L?1J0.14@E?1J?0.1 G2!000L?1J0.14@E?1J?0.14M?1I0.14@ 4M?1I0.14@ 2 ?1J1.148@  G5!000?3.4331@ G5!000?3.4331@ I G3!000?2.3216@?0.5194@ G3!000?2.3216@?0.5194@ I G2!000?1.6467@?0.3506@ G2!000?1.6467@?0.3506@

 G17!165.50 I G3!617.52 I G1!154.67  G21!937.69. :inancial calc/lator sol/tionC ?,n tho/sands@ ,np/tsC : 0  0 : 1  5 "*  5 : 2  3 " *  3 :3  2 " *  2 ,  14. D/tp/tC "#$  21.93726  G21!937.26. "/&e "/&eri rica cal l sol/ sol/ti tion on diffe differs rs fro& fro& calc calc/l /lat ator or sol/t sol/tio ion n d/e d/e to No#e: ro/nding. 64 .

(12.2) NPV i&e lineC 0

Diff: $

?,n tho/sands@

1

2

3

4

5

6

7

8

9

30

30

30

30

35

35

35

35

35

r  10

E150

Answer: d

10 )rs.

40

NPV = ?

"/&erical sol/tionC "#$  G30!000L?1J0.10@E?1J?0.10M?1I0.10@ 4@N I G35!000L?1J0.10@E?1J?0.10M?1I0.10@ 5@N?1J1.10 4@ I G40!000?1J1.10 G40!000?1J1.1 0 10@ E G150!000  G30!000?3.1699@ I G35!000?3.7908@?0.6830@ I G40!000?0.3855@ E G150!000  G51!136.07

G51!136.

≈

:inancial calc/lator sol/tionC ?,n tho/sands@ ,np/tsC : 0  E150 : 1  30 " *  4 :2  35 " *  5 : 3  40 ,  10. D/tp/tC "#$  G51.13824  G51!138.24 G51!138. ≈

65 .

(12.3) efore#a' cash flows i&e lineC 0 1 2 ,--  15

E10!000

#;  K

#;

Answer: b 3

4

#;

#;

Di D iff: $ 10 )ears

#;

"/&erical sol/tionC %  afterEta cash flow. )  (eforeEta cash flow. %  )?1 E @. G10!000 G10!000 % G1!992.51 )

    

%L?1J0.15@E?1J?0.15M?1I0. %L?1J0.15@E?1 J?0.15M?1I0.15@ 15@ 10@N %?5.0188@ G1!992.51. )?1 E 0.40@ G3!320.85 G3!321. ≈

:inancial calc/lator sol/tionC ,np/tsC "  10 ,  15 #$  E10!000. D/tp/tC #;  G1!992.52. eforeEta :  G1!992.52J0.6 G1!992.52J0.6  G3!320.87 G3!321. ≈

66 .

(12.,) $odified IRR i&e lineC 0 1 r  12

E275!000 "#$  K

Answer: d 2

73!306

73!306

3

73!306

8

)ears

73!306

"/&erical sol/tionC $  G73!306L??1I0.12@ G73!306L??1I0.12@ [email protected]  G73!306?12.300@  G901!663.80. G275!000 

0.30499 

G901!663.80 ?1 I ;,-- @8 1 8

? 1 I ; ,- -@

Diff: $

?1 I ;,--@ 8  3.27869. 3.278691J8  1 I ;,-;,--  16. :inancial calc/lator sol/tionC EG901!641.3 1. T ,np/tsC "  8 ,  12 #;  73!306. D/tp/tC :$  EG901!641.31. D/tp/tC ,  16.0. !I"" ,np/tsC "  8 #$  E275!000 :$  901!641.31. Alternate method ,np/tsC : 0  0 : 1  73!306 " *  8 ,  12. D/tp/tC ":$  G901!641.31. ,np/tsC : 0  E275!000 : 1  0 "*  7 : 2  901!641.31. D/tp/tC ,--  16.0  ;,--. 67 .

(12.,) $IRR and AP$ i&e lineC 0

1

2

1!000

1!000

r  16

E2!028

Answer: d

3

)ears

1!000 1!160.00 1!345.60 er&inal val/e ?$@  3!505.60

tep 1

alc/late the historical (eta. -egressi -egression on ðodC ðodC :inancia :inancial l calc/lat calc/latorC orC =ifferen =ifferent t calc/lat calc/lators ors have different list entr' proced/res and ke' stroke se/ences. Qnter Qnter 'Elis 'ElistC tC ,np/tsC ,np/tsC ,te&?1@ ,te&?1@  9 ,"#P ,"#P ,te&?2@ ,te&?2@  15 15 ,"#P ,"#P ,te&?3@  36 ,"#P. Qnter Qnter Elis ElistC tC ,np/tsC ,np/tsC ,te&?1@ ,te&?1@  6 ,"#P ,"#P ,te&?2@ ,te&?2@  10 10 ,"#P ,"#P ,te&?3@  24 ,"#P /se linear &odel. D/tp/tC & or slope  1.50. raphicalJn/&erical ðodC lope  -iseJ-/n  ?36 E 9@J?24 E 6@  27J18  1.5. eta  1.5.

tep 2

alc/late cost of e/it' e/it' /sing #; and (eta and given inp/tsC re  r-: I eta?-# ;@  7.0 I 1.5?6@  16.0.

tep 3

alc/late ;,--C "/&erical sol/tionC alc/late ter&inal val/e ?$@C $  G1!000L??1I0.16@ [email protected]  G1!000?3.5056@  G3!505.60. Pse #$ ?cost@ and $ to solve for ;,--C G2!028  $J?1 I ;,--@ 3 G2!028  G3!505.60J?1 G3!505.60J?1 I ;,--@ 3 3 ?1 I ;,--@  1.7286 1 I ;,--  1.20 ;,--  20. :inancial calc/lator sol/tionC er&inal val/eC /sing cash flows ,np/tsC : 0  0 : 1  1000 " *  3 ,  16. G3!505.60. ;,--C /sing $; ,np/tsC "  3 #$  E2028 :$  3!505.60. D/tp/tC

68 .

Diff: $

,  20.01  ;,--


D/tp/t D/tp/tC C

":$ 

20.

≈

Answer: c

Diff: $

i&e lineC

: /&/lative ":

?,n tho/sands@ 0

1

2

E100

E500

100

110

121

133.1

146.41

E100

E600

E500

E390

E269

E135.9

10.51

#a'(ack  5 I

69.

G135.9 G146.41

 5.928 'ears

5

6

10

6 'ears.

Answer: c

Diff: $

alc alc/l /lat ate e the the #$ of the the cas cash h flo flows wsC C #$5  G60!000L?1J0.10@E?1J?0.10M?1.10@ 5@N  G60!000?3.7908@  G227!448.

tep tep 2

alc alc/l /lat ate e the the )ear )ear 0 o/t o/tfl flow owC C he o/tflow at t  0 is is % where G227!448 G227!448 E %  G75!000. G75!000.  EG152!448.

0

G32!448 G60!000

 2.54 'ears.

Answer: e

1

3

50!000

100!000

150!000

40!000

25!000

50!000

100!000

150!000

40!000

25!000

2

1.1 =isco/nted :s E200!000

?1.1@

45!454.55

=isco/nted : E200!000.00 45!454.55 82!644.63 #a'(ack 112!697.22 27!320.54 15!523.03

4

Diff: $

2

r  10

:s E200!000

3 4 5

% or : 0

alc alc/l /lat ate e the the reg/ reg/la lar r pa' pa'(a (ack ckC C )ear : /&/lative : 0 EG152!448 EG152!448 1 60!000 E92!448 2 60!000 E32!448 3 60!000 27!552 4 60!000 87!552 5 60!000 147!552

(12.-) Disco%n#ed a&bac

0 1 2

)ears

≈

tep tep 1

o the pa'(ack is 2 I

3

?1.1@

82!644.63 112!697.22 112!697.22

5

4

5

?1.1@

?1.1@

27!320.54 27!320.54

15!523.03 15!523.03

/&/lative : E200!000.00 E154!545.45 E71!900.82

#a'(ack period  2 'ears I 71 .

4


tep tep 3

70 .

3

I40!796.40 I68!116.94 I83!639.97 G71!900.82  2.638 'ears. G112!697.22

(12.-) Disco%n#ed a&bac =i =isco/nted )ear ash :low ash :low 0 EG100!000 EG100!000.00 1 40!000 36!363.64 2 90!000 74!380.17 3 30!000 22!539.44

Answer: b

/&/lative ash :low EG100!000.00 E63!636.36 10!743.81 33!283.25

Diff: $

4

60!000

40!980.81

=isco/nted #a'(ack  1 I 72 .

73 .

74!264.06

G63!636.36  1.86 'ears. G74!380.17

(12.-) Disco%n#ed a&bac Answer: d Diff: $ he s/& of the #$s of the t  1! t  2! and t  3 cash flows at t  0 for #ro*ect  is is G99!474.08. G99!474.08. h/s! the disco/nted disco/nted pa'(ack pa'(ack period period of #ro*ect  eceeds 3 'ears and #ro*ect  is not accepta(le. accepta(le. he #$s of the t  1! t  2! and t  3 cash cash flows flows at t  0 for for #ro* #ro*ec ect t  are are G45! G45!45 454. 4.55 55! ! G16!528. G16!528.93! 93! and G22!539 G22!539.44! .44! respect respectivel ivel'. '. hese hese #$s s/& to G84!522.92 G84!522.92! ! whic which h is grea greate ter r than than the the cost cost of the the pro* pro*ec ect! t! indi indica cati ting ng that that the the disco/nted pa'(ack period period is less than 3 'ears. h/s! #ro*ect #ro*ect  will (e /ndertaken. (o".) NPV and a&bac Answer: b Diff: $ :irst! :irst! find find the &issing &issing t  0 cash cash flow. flow. ,f pa'(ack pa'(ack  2.5 'ears 'ears! ! this i&plies t  0 cash flow &/st (e EG2!000 E G3!000 I ?0.5@G3!000  EG6!500.

"#$  EG6!500 I

G2!000 1.12

I

G3!000 2

?1.12@

I

G3!000 3

?1.12@

I

G1!500 4

?1.12@

 G765.91. 74 .

(12.+) $%l#ile IRRs i&e lineC 0

Answer: c 1

,--  K

E10!000

Diff: 

2

100!000

E100!000

"/&erical sol/tionC This problem can be sol#ed numerically but re$uires an iterati#e process of trial and error usin% the possible solutions pro#ided in the problem& 12.5 In#esti%ate first claim: r' r  ,--  13 and r  12.5 2 "#$r  13  E10!000 I 100!000J1.13 E 100!000J?1.13@  180.91. "#$r  12.5  E10!000 I 100!000J1.125 E 100!000J?1.125@ 2  E123.46. he first clai& appears to (e correct. he ,-- of the pro*ect appears to (e (etween 12.5 and 13.0. In#esti%ate second claim: r' r  800 and r  780 "#$r  800  E10!000 I 100!000J9 E 100!000J?1 I 8@ 2  E10!000 I 11!111.11 E 1!234.57  E123.46. "#$r  780  E10!000 I 100!000J8.8 E 100!000J?1 I 7.8@ 2  E10!000 I 11!363.64 E 1!291.32  72.32. he second clai& also appears to (e correct. he ,-- of the pro*ect flows also appears to (e a(ove 780 (/t (elow 800. elow is a ta(le of vario/s disco/nt rates and the corresponding corresponding "#$s. =isco/nt rate ?@ 12.0 12.5 12.7 13.0 25.0 400.0 800.0 787.0 780.0

"#$ ?G 433.67@ ?123.46@ ?1.02@ 180.91 6!000.00 6!000.00 ?123.46@ 2.94 72.32

,-- 1

≈

12.7

,-- 2

≈

787

' rand rando& o&l' l' sele select ctin ing g vari vario/ o/s s cost costs s of capi capita tal l and and calc calc/l /lat atin ing g the the pro*ectero at these val/es of r. h/s! there are &/ltiple ,--s. 75

.

(12.3) IRR i&e lineC 0

Answer: c

r  14 ,--  K

E200!000

1

2

44!503

10 )ears

44!503

44!503

:inancial calc/lator sol/tionC ,np/tsC : 0  E200!000 : 1  44!503 " *  10. 76 .

(12.3) IRR i&e lineC 0 ,--  K

D/tp/tC ,--  18. Answer: c

1

2

#;  E100

Diff: E

Diff: E

20 )ears

E100

E100 :$  3!310

:inancial calc/lator sol/tionC ,np/tsC : 0  0 :1  E100 " *  19 : 2  3!210. D/tp/tC ,--  5.0. Alternate method annuity calculation ,np/tsC "  20 #;  E100 :$  3!310. D/tp/tC ,  5.0 77 .

(12.3) IRR and "%#%all& e'cl%sie ro*ec#s eca/se eca/se the two pro*ects pro*ects are &/t/all' &/t/all' ecl/siv ecl/sive! e! higher positive "#$ is the R(etterR pro*ect.

0 

r  12

E1!100

"#$  G107.46. 0 S

1

2

3

1!000

350

50

1

2

3

0

300

Answer: d Diff: E the pro*ect with the

,--   20.46.

r  12

E1!100

1!500

"#$S  G206.83. ,-- S  19.08. #ro*ect S is the R(etterR pro*ect its ,--  19.08. 78 .

79 .

80 .

(12.4) NPV and IRR "#$  G243.43 ,--   23.38. "#$S  G535.13 ,-- S  20.00. $al/e sacrificedC G535.13 E G243.43  G291.70.

Diff: E

(12.4) NPV and IRR Answer: e Diff: E Qnter the cash flows for each pro*ect into the cash flow register on the calc/lator and get the "#$ and ,--. "#$  G15!200 ,--   21.3811. "#$  G7!092 ,--   19.2783. #ro*ect  has the highest ,--! so the answer is G15!200. (o".) NPV IRR and a&bac #a'(ack  2 I 300J500  2.6 'ears. Psing the cash flow register! calc/late "#$ and ,--C ,--  21.22.

"#$  G260.43 81.

Answer: b

Answer: d

D Di iff: E

Answer: d

Di Diff: E

G260.

≈


0

r  10

1

2

3

4

 E8!000

5!000

5!000 E8!000 E3!000

,--  16.26. "#$  G1!237.76. 0

r  10

5!000

?etended "#$@

1

2

S E11!500 4!000 ,--S  14.66. "#$S  G1!179.46.

82 .

5!000

3

4!000

4

4!000

4!000

(12.3) IRR i&e lineC

: :

Answer: d

,--



K

0 ,--



K 1

E2!000 E2!000

2

0 832

3

0 832

Diff: $

4 )ears

0 832

3!877 832

:inancial calc/lator sol/tionC !achine A ,np/tsC : 0  E2!000 : 1  0 " *  3 : 2  3877. D/tp/tC ,--  17.996 18. ,np/tsC : 0  E2!000 : 1  832 " *  4. D/tp/tC ,--  24.01 24. ≈

!achine B

≈

83.

(12.3) IRR Answer: c :inancial calc/lator sol/tionC Project A ,np/tsC "  1 #$  E10!000 :$  11!800. D/tp/tC ,  18  ,-- . Project ' ,np/tsC "  3 #$  E12!000 #;  5!696.

D/tp/tC ,  19.99 84 .

20  ,-- .

≈

(12.3) IRR of %neen 5 s#rea" i&e lineC 0 1

Diff: $

2

3

,--  K

Answer: d 4

5

6

D Di iff: $

)ears

E3!000!000 2!000!000 2!000!000 E500!000

:inancial calc/lator sol/tionC (In millions) ,np/tsC : 0  E3 : 1  2 "*  2 : 2  E.5. D/tp/tC ,--  12.699 12.70. ≈

85 .

(12.3) IRR of %neen 5 s#rea"

Answer: e

i&e lineC (In millions) 0 ,--  K 1 2

3

4

5

E5

2

2

2

1

1.5

D Di iff: $

)ears

:inancial calc/lator sol/tionC (In millions) ,np/tsC : 0  E5 : 1  1.0 : 2  1.5 : 3  2.0 " *  3. D/tp/tC ,--  18.37. 86.

(12.4) NPV IRR and 0%n os#s Answer: d Diff: $ he G10 &illion on the feasi(ilit' st/d' is irrelevant! since it is a s/nk cost. Psing a financial calc/lator! :?0@E100! :?1@E20! :?2@80! :?3@90.

With W11! "#$  G12.719 G12.72 and ,--  15.945 16. lternativel'! "#$  E100 I E20J?1.11@ I 80J?1.11@ 2 I 90J?1.11@ 3  12.719 and "#$  E100 I E20J?1.15945@ I 80J?1.15945@ 2 I 90J?1.15945@ 3  0 so ,--  15.945. ≈

≈

87 .

(12.4) NPV and IRR i&e lineC 0 r  12 1

ash flows  E1!100 "#$  K ash flows S E1!100 "#$S  K

900 ,--  K 0 ,--S  K

Answer: a 2

3

4

350

50

10

300

500

850

Diff: $

)ears

:inancial calc/lator sol/tionC 'alcul 'alculate ate the P P and I"" of each each projec project t then then select select the I"" of the hi%her P project #ro*ect  ,np/tsC : 0  E1!100 : 1  900 : 2  350 : 3  50 : 4  10 ,  12 D/tp/tC "#$   24.53 ,--   13.88. #ro*ect S ,np/tsC : 0  E1!100 : 1  0 : 2  300 : 3  500 : 4  850 ,  12 D/tp/tC "#$ S  35.24 ,-- S  13.09. #ro*ect S has the higher "#$ and its ,--  13.09. 88.

(12.4) NPV rofiles Answer: d Diff: $ :irst! solve for the crossover crossover rate. ,f 'o/ s/(tract s/(tract the cash cash flows ?:s@ ?:s@ of #ro*ect  fro& the :s of #ro*ect ! then the differential :s are

6:0  EG10!000! 6:1  EG40!000! 6:2  0! 6:3  G20!000! and :4



G40!000. G40!000. Qntering Qntering these these :s and solvi solving ng for ,--J),--J)- 'ields 'ields a crossover crossover rate of 6.57. 6.57. h/s! if the the cost of capital is 6.57! then #ro*ects  and  have the the sa&e "#$. "#$. ,f the cost cost of capita capital l is less than than 6.57! 6.57! then then #ro*ect  has a higher "#$ than #ro*ect ! since #ro*ect ed as &/ch for having large cash inflows farther in the f/t/re than #ro*ect . 89 .

90 .

91 .

(12.4) rossoer ra#e Answer: b Diff: $ :ind the differences (etween the two pro*ects< respective cash flows as followsC ?: E :@. :0  E5!000 E ?E5!000@  0. :1  200 E 3!000  E2!800. :2  E2!200. :3  2!200. :4  4!800. Qnter these :s and find the ,--  16.15 which is the crossover rate. (12.4) rossoer ra#e Answer: b Diff: $ :irst! find the differential :s (' s/(tracting s/(tracting ea&  :s fro& ea&  :s ?or vice versa@. Qnter these these into the cash flow register register then then solve to find ,--J)- to get the disco/nt rate for which he is indifferent (etween the two contracts! 11.35. (12.4) rossoer ra#e Answer: b /(tract #ro*ect 2 cash flows fro& #ro*ect 1 cash flowsC :0  E100 :1  E600 :2  E200 :3  0 :4  400 :5  700

Diff: $

#/t these in the cash flow register and solve for the ,--  5.85. 92 .

(12.4) rossoer ra#e Answer: d Diff: $ :ind the differential cash flows (' s/(tracting s cash flows fro& s

cash flows for each 'ear. :0  E2!000 :1  E6!000 :2  1!000 :3  5!000 :4  5!000 Qnter these cash flows and solve for the ,--  crossover rate  13.03. 93.

(12.4) rossoer ra#e Answer: c Diff: $ he crossover rate is the point where the two pro*ects will have the sa&e "#$. o find the crossover rate! s/(tract :  fro& : C EG100!000 E EG100!000  0. G40!000 E G30!000  G10!000. G25!000 E G15!000  G10!000. G70!000 E G80!000  EG10!000. G40!000 E G55!000  EG15!000.

Qnter these into 'o/r : register and solve for ,--  11.21. 94.

(12.4) rossoer ra#e Answer: d Diff: $ :ind :ind the the diff differ eren enti tial al cash cash flow flows s to co&p co&p/t /te e the the cros crosso sove ver r rate rate. . /(tracting #ro*ect  cash flows fro& #ro*ect  cash flows! we o(tain the following differential cash flowsC

 E  ash :low EG100 70 40 20 0 E20

)ear 0 1 2 3 4 5

,np/t the cash flows into 'o/r calc/latorTs cash flow register and solve for the ,-- to o(tain the crossover rate of 9.32 percent. 95 .

(12.,) $odified IRR i&e lineC ?,n &illions@ &illions@

Answer: e

Diff: $

r  12 0

1

;,--  K

E1

E1

2

3

4

5

6 )rs

0.5

0.5

0.5

0.5

1.0

:inancial calc/lator sol/tionC alc/late $ ?er&inal val/e@ ,np/tsC : 0  0 :1  500!000 " *  4 :2  1!000!000 ,  12. D/tp/tC ":$  G3!676!424. alc/late ;,-,np/tsC "  6 #$  E1!892!857 :$  3!676!424. D/tp/tC ,  11.6995 96 .

11.70.

≈

(12.,) $odified IRR ?i&e line cash flows shown in tho/sands.@ 0

r  12

E7!000

1

500

10

500 E1!000

E7!000 E322 E7!322  #$ of o/tflows

Answer: b

11

20

500

500

$ of inflowsC

36!026

Diff: $

'alculation of P of outflows: :0  E7!000 :1E9  0 :10  E1!000 ,  12

olve for "#$  EG7!321.97 EG7!322. 'alculation of T of inflows: "  20 ,  12 #$  0 #;  500 olve for :$  $  G36!026.22 G36!026. 'alculation of !I"": "  20 #$  E7!322 #;  0 :$  36!026 olve for ,  ;,--  8.29. "oteC "oteC ,--  2.52 2.52 and "#$  EG3!587 EG3!587!251 !251. . less than W  12. ≈

≈

97 .

(12.,) $odified IRR tep 1 :ind the :$ of cash cash inflowsC ?G25!000@?1.12@ 4  G 39!337.98 ? 25!000@?1.12@ 3  35!123.20 2 ? 50!000@?1.12@  62!720.00 ? 50!000@?1.12@  56!000.00 ? 50!000@  50!000.00 :/t/re $al/e  G243!181.18

oth are are consisten consistent t with ;,-;,--

Answer: e

Diff: $

lternativel'! lternativel'! with a financial calc/lator calc/lator 'o/ can find the :$ of the cash inflows (' first finding the "#$ of these inflows and then finding the :$ of their "#$. :0  0 :1E2  25!000 :3E5  50!000 ,  12 olve for "#$  G137!987.53. "  5 ,  12 #$  E137!987.53 #;  0 olve for :$  G243!181.18. tep 2 :ind the ,-- which e/ates the cash inflows and o/tflowsC "  5 #$  E100!000 #;  0 :$  243!181.18 olve for ,  19.45. 98.

(12.,) $odified IRR

Answer: b

Diff: $

tep tep 1

:ind :ind the the ter&in ter&inal al val/e val/e ?$@ ?$@ of the the infl inflows ows with with 'o/r 'o/r calc/l calc/lato ator r as followsC :0  0 : 1  125000 : 2  140000 : 3  0 : 4  100000 ,J)-  10 and solve solve for for "#$  G297!6 G297!640.1 40.1885. 885. o&po/nd o&po/nd this this n/&(er n/&(er 4 'ears 'ears into the the f/t/re f/t/re to get the the $C ?G297!64 ?G297!640.18 0.1885@? 85@?1.10 1.10@ @4  G435!775.

tep tep 2

hen hen! ! fin find d the the #$ of the the o/t o/tfl flow owsC sC

:0  E200000 : 1  0 : 2  0 : 3  E50000 : 4  0 ,J)-  10 and solve for "#$  G237!565.74. tep 3

99.

"et! find the ;,--C "  4 #$  E237565.74 #;  0 :$  435775 and solve for ,J) 16.38.

(12.,) $odified IRR Answer: d he /pEfront cost can (e calc/lated /sing the pa'(ackC G400 I ?G500@?0.5@  G650.

Diff: $

he ter&inal val/e of the cash inflows areC ?G400@?1.1@2 I ?G500@?1.1@ I G200  G1!234. Pse 'o/r calc/lator to o(tain the ;,--C Qnter "  3! #$  E650! #;  0! and :$  1234. 100.

olve for ;,--  ,  23.82.

(12.,) $IRR and IRR

0

r  8

E20!000 ,--  22.11.

1

Answer: e

Diff: $

Answer: b

Diff: $

5

7!000

7!000

alc/late ;,-- C :ind $ of cash inflowsC "  5 ,  8 #$  0 #;  7!000. olve for :$  $  G41!066.21. :ind ;,--   15.48C "  5 #$  E20!000 #;  0 :$  41!066.21. olve for ,  ;,--  15.48. /&  22.11 I 15.48  37.59. 101 .

$IRR and IRR ?i&e line in tho/sands@ 0 1 r  15

E10!000

5!000

2

5!000 E6!000 E1!000

3

5!000

4

5!000

tep 1

alc/late ,-- (' inp/tting the following into a calc/latorC :0  E10!000!000 :1  5!000!000 :2  E1!000!000 :3E4  5!000!000 olve for ,--  13.78.

tep 2

alc/late ;,--C a. alc alc/l /lat ate e #$ of the the o/tf o/tflo lows wsC C :0  E10!000!000 :1  0 :2  E1!000!000 ,  15 olve for "#$  EG10!756!143.67. EG10!756!143 .67. (. alc/lat alc/late e :$ of the inflows inflows (' inp/ttin inp/tting g into a calc/lat calc/latorC orC :0  0 :1  5!000!000 :2  0 :3E4  5!000!000 :or ,15! "#$ G10!494!173.48. G10!494!173 .48. :$?10!494!173.478@?1.15@ 4  G18!354!375.00. c. alc/ alc/la late te ;,-,--C "  4 #$  E10!756!143.67 E10!756!143.67

#;  0 :$  18!354!375.00 18!354!375.00 olve for ,  14.29. tep tep 3

102.

alc/l alc/late ate the differ differenc ence e (etwe (etween en the the pro* pro*ect ect
(12.11) Relace"en# chain Answer: c Di Diff: $ o find the "#$ of the s'ste& we &/st /se the replace&ent chain approach.

i&e 0 1 2 3 4 5 6

'ste& 

'ste& 

E100!000 60!000 60!000 E 100!000  E40!000 60!000 60!000 E 100!000  E40!000 60!000 60!000

E100!000 48!000 48!000 48!000 E 110!000  E62!000 52!800 52!800 52!800

Pse the : ke' ke' to enter the cash cash flows for each period. ,J)-  11. his sho/ld give the following "#$sC "#$  G6!796.93. "#$   G31!211.52. o&p/t o&p/ter er s'ste s'ste& &  create creates s the &ost val/e val/e for the fir&! fir&! so the correct correct answer is c. 103.

(12.11) Relace"en# chain Answer: e Di Diff: $ he :s and "#$s ?calc/lated with ,  r  10.5@ are as followsC

t

#ro*ect 

#ro*ect  0 E100!000 E50!000 1 40!000 30!000 2 40!000 30!000

3 40!000

30!000 E 55!000  E25!000 E25!000 4 40!000 32!000 5 40!000 32!000 6 40!000 32!000 "#$ G71!687.18 ≈

G71!687

G41!655.58

≈

G41!656 104.


Answer: d

;achine  ?i&e line in tho/sands@C 0 1E4 5 r  12

6E10

E1!000

375

350

350 E1!200 E850

With a financial calc/lator inp/t the followingC

Di Diff: $

:0  E1!000!000 :1E4  350!000 :5  E850!000 :6E10  375!000 ,  12 olve for "#$   G347!802. ;achine  ?i&e line in tho/sands@C 0 1E9 10 r  12

E1!500

400

400 100 500

:0  E1!500!000 :1E9  400!000 :10  500!000 ,  12 olve for "#$   G792!286.54. G792!286.54. 105 .

(12.11) Relace"en# chain Answer: d he :s and "#$s ?calc/lated with ,  r  12@ are as followsC

)ear 0 1 2 3 4 5 6 7 8 "#$ 106 .

-#% E5.4 3.6 3.6 1.8 1.8 U 5.4  E3.6 3.6 3.6 1.8 1.8

-# E5.4 2.4 2.4 2.0 2.0 2.0 2.0 2.0 2.0

5.085

5.211

(12.11) Relace"en# chain ;achine C tep 1 :ind "#$ C :0  E450!000 :1E2  350!000 ,  10 olve for "#$   G157!438.02.

tep 2

Answer: c

Diff: $

Diff: $

:ind "#$ of etended lifeC Qtended "#$  G157!438.02 I G157!438.02J?1I0. G157!438.02J?1I0.10@ 10@ 2  G287!552.08.

;achine C tep 1 :ind "#$ C :0  E1!000!000 :1E3  350!000 :4  450!000 ,  10 olve for "#$  G177!754.25. 107 .

(o".) $%#%all& e'cl%sie ro*ec#s i&e lineC ,--  K 0 ,--  K 1  : :

E100!000 E100!000

39!500 0

Answer: b

2

39!500 0

3

)ears

39!500 133!000

Diff: $

:inancial calc/lator sol/tionC Project A: ,np/tsC : 0  E100!000 : 1  39!500 " *  3. D/tp/tC ,--   8.992 9.0. Project B: ,np/tsC : 0  E100!000 : 1  0 "*  2 : 2  133!000. ≈

D/tp/tC ,--   9.972 108 .

109.

10.0.

≈

(12.2) NPV Answer: c Diff:  tep tep 1 -/n a regres regressio sion n to find find the corpor corporate ate (eta. (eta. ;arket ;arket ret/rn ret/rns s are the %Einp/t val/es! val/es! while while )
tep tep 2

:ind :ind the pro*e pro*ect ct
tep tep 3

:ind :ind the the co&pa co&pan' n'
tep tep 4

"ow find find the the pro*ec pro*ect
(12.2) PV of cash flows /rrent 0

Answer: c 1

2

3

1!000

1!000

1!000

11J12  0.9167

leaseC

60

11J12 0.9167

"

,J)-

#$

"ew

Diff:  60 ;onths

1!000

1!000

0

#;

:$

E45!993.03 0

0.9167

leaseC

1

2

3

4

0

0

0

0

5

6

0

0

7

60 ;onths

1!050

1!050

:0  0 :1E6  0 :7E60  1!050 ,  11J12  0.9167 olve for "#$  EG42!189.97. herefore! the #$ of pa'&ents /nder the proposed lease wo/ld (e less than the #$ of pa'&en pa'&ents ts /nder /nder the old lease lease (' G45!99 G45!993.0 3.03 3 E G42!18 G42!189.9 9.97 7  G3!803.06. all' sho/ld sho/ld accept accept the new lease lease (eca/se (eca/se it wo/ld wo/ld raise her theoretical net worth (' G3!803.06. 110 .

(12.4) NPV rofiles i&e lineC

Answer: b

,--  K

0 ,--  K :% :) :%

E )

E100 E100 0

1

2

3

4

50 10 40

40 30 10

30 40 E10

10 60 E50

:inancial calc/lator sol/tionC Project X ,np/tsC : 0  E100 : 1  50 : 2  40 : 3  30 : 4  10. D/tp/tC ,--  14.489 14.49. ≈

Diff: 

)ears

Project  ,np/tsC : 0  E100 : 1  10 : 2  30 : 3  40 : 4  60. D/tp/tC ,--  11.79. 'alculate the Ps of the projects at r * + discount rate& "#$%!r  0  E100 I 50I 40 I 30 I 10  30. "#$)!r  0  E100 I 10 I 30 I 40 I 60  40. 'alculate the I"" of the differential project, i&e&, Project % E ,--% E ),np/tsC : 0  0 : 1  40 : 2  10 : 3  E10 : 4  E50. D/tp/tC ,--  7.167 7.17.

)

≈

olel' /sing the calc/lator we can deter&ine that there is a crossover point point in the relevan relevant t part of an "#$ "#$ profile profile graph. graph. #ro*ect #ro*ect % has the the higher ,--. #ro*ect ) has has the higher "#$ at r  0. he crossover rate is 7.17 and occ/rs in the /pper right /adrant. 111.

(12.,) $IRR and NPV i&e lineC

Answer: c

Diff: 

Project X

0

r  12 ;,--  K

E2!000

1

2

3

200

600

800

4

)ears

1!400.00 1!400.00 r  12

896.00

r  12

752.64

r  12

280.99 er&inal $al/e ?$@  3!329.63

;,-- %  K  13.59

#$ of $  2!000 "#$  0 i&e lineC Project )

0

r  12 ;,--  K

E2!000

1

2!000

2

3

200

100

4

75.00 r  12

r  12 r  12

)ears

112.00 250.88 2!809.86

er&inal $al/e ?$@  3!247.74 ;,-- %  K  12.89

#$ of $  2!000 "#$  0

:inancial calc/lator sol/tionC Project X ,np/tsC : 0  0 : 1  200 : 2  600 : 3  800 : 4  1!400 ,  12. D/tp/tC ":$%  G3!329.63 "#$ %  G2!116.04. ,np/tsC "  4 #$  E2!000 :$  3!329.63. D/tp/tC ,--%  13.59  ;,-- %. Project  ,np/tsC : 0  0 : 1  2!000 : 2  200 : 3  100 : 4  75 ,  12. D/tp/tC ":$)  G3!247.74 "#$ )  G2!063.99. ,np/tsC "  4 #$  E2!000 :$  3!247.74. D/tp/tC ,--)  12.885 12.89  ;,-- ). "ote "ote that that the (ette (etter r pro*ec pro*ect t is % (eca (eca/s /se e it has a higher higher "#$. "#$. ≈

,ts ,ts

corresponding ;,--  13.59. "#$%  G2!116.04 E G2!000  116.04. "#$)  G2!063.99 E G2!000  63.99. "#$% + "#$ ). ;,-- of the better pro*ect is 13.59. pro*ect 112 .

113 .

(12.,) $odified IRR Answer: e Diff:  Pse cash flow registers to deter&ine the "#$ of each pro*ectC "#$  G1!237.11 "#$ S  G1!106.82. ince "#$  + "#$ S we need to calc/late ;,-- . alc/late the #$ of cash o/tflowsC :0  E3!000 : 1E3  0 :4  E500 ,  11. olve for "#$  G3!329.37. alc/late the $ of cash inflowsC :irst find the c/&/lative #$! then take forward as a l/&p s/& to find the $. alc/late #$C : 0  0 : 1  2!500 : 2  1!500 : 3  1!500 ,  11. olve for "#$  G4!566.47. alc/late $ or :$C "  4 ,  11 #$  E4!566.47 #;  0. olve for :$  G6!932.22. alc/late ;,--C "  4 #$  E3!329.37 #;  0 :$  6!932.22. olve for ;,--  ,  20.12. (12.,) $odified IRR Answer: d Diff:  -irst, calculate the present #alue of costs: "  4! ,J)-  10! #;  0! :$  10!000! and solve for #$  EG6!830.13. dd EG100!000 I E6!830.13  EG106!830.13. Then, find the terminal #alue of inflows: hift to Q," ;D=Q! "  3! ,J)-  10! #$  0! #;  E50!000! and solve for :$  G182!050.

:inall'! shift (ack to Q"= &ode! and solve for ;,--! where "  4! #$ ! E106!830.13! E106!830.13! #;  0! :$  182!050! and solve for ,J)-  14.25. 114.

(12.,) $odified IRR Answer: d Diff:  -irst, find P of all cash outflows: #$ of : 0 is EG13!000. #$ of : 4 is E1!500 disco/nted at 11 for 4 periods or EG988.10. EG988.10. h/s! the the #$ of all cash o/tflows is EG13!988.10. EG13!988.10. .econd, find the - at t * / of all cash inflows: he s/& of these cash inflows inflows is the the pro*ect
o find find the ;,-;,--! ! ente enter r "  4! #$  E13! E13!98 988. 8.10 10! ! 34!038.37! which 'ields ,J)-  ;,--  24.90. 115 .

#; #;



0! and

:$



(12.,) $odified IRR Answer: e Diff:  -irst, find the company0s wei%hted a#era%e cost of capital: Were given the (eforeEta cost of de(t! r d  10. We can find the cost of e/it' as followsC rs  0.06 I 0.05?1.1@  0.115 or 11.5. h/s! the W isC r  0.4?0.10@?1 E 0.3@ I 0.6?0.115@  0.097 or 9.7. .econd, the P of all cash outflows can be calculated as follows: #$ of : 4C "  4! ,  9.7! #;  0! :$  40!000 and solve for #$  E G27!620.62. otal #$ osts  EG50!000 E G27!620.62  EG77!620.62. Third, find the terminal #alue of the project at t * /:

:$ of : 1 at t  4 is calc/lated as followsC followsC "  3! ,  9.7! #$  E35!000! #;  0! 0! and solve solve for :$  G46!204!89. G46!204!89. i&ilarl'! the :$s of : 2 and : 3 are fo/nd fo/nd to (e G51!746.59 G51!746.59 and G65!820! respectivel'. respectivel'. /&&ing these :$s give gives s a ter& ter&in inal al val/ val/e e of G46! G46!20 204. 4.89 89 I G51! G51!74 746. 6.59 59 I G65! G65!82 820. 0.00 00  G163!771.48. :inall'! the ;,-- can (e calc/lated as "  4! #$  E77!620.62! E77!620.62! #;  0! :$  163!771.48! and solve for ,  ;,--  20.52. 116.

(12.,) $odified IRR Answer: c Diff:  -ind the present #alue of the outflows: t  0C E1!000 t  2C "  2! ,  12! #;  0! :$  300! and solve for #$  EG239.1582. t  4C "  4! ,  12! #;  0! :$  700! and solve for #$  EG444.8627. otal #$ osts  EG1!000 E G239.1582 E G444.8627  EG1!684.0209. -ind the future #alue of t  1C "  4! ,  12! #$ t  3C "  2! ,  12! #$ t  5C "  0! ,  12! #$ otal :$ ,nflows  G314.7039

the inflows:  E200! #;   E900! #;   E600! #;  I G1!128.96 I

0! and 0! and 0! and G600 

solve for :$  G314.7039. solve for :$  G1!128.96. solve for :$  G600. G2!043.6639.

Then find the !I"": "  5 #$  E1!684.0209 #;  0 :$  2!043.6639

olve for ;,--  ,  3.9471 117.

3.95.

≈

(12.,) $odified IRR here are three steps to getting the ;,--. 1. -ind P of outflows: EG700 I EG200J?1.1@2  EG865.2893. 2. -ind - of inflows: G400?1.1@3 I G600?1.1@ I G500  G1!692.40. 3. -ind !I"": "  4 #$  E865.2893 #;  0 :$  1!692.40

olve for ,  ;,--  18.2593

18.26.

≈

Answer: b

Diff: 

IFM10 Ch 12 Test Bank

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