FIN 3310 Chapter Notes - Chapter 9: Cash Flow, Net Present Value
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Question: | ||||
The Sanders Electric Company is evaluating two projects for possible inclusion in the firmâs capital budget. Project M will require a $37,000 investment while project Oâs investment will be $46,000. After-tax cash inflows are estimated as follows for the two projects: | ||||
Year | Project M | Project O | ||
1 | $12,000 | $10,000 | ||
2 | 12000 | 10000 | ||
3 | 12000 | 15000 | ||
4 | 12000 | 15000 | ||
5 | 15000 | |||
a. | Determine the payback period for each project. | |||
Payback (M) = | ||||
Payback (O) = | ||||
b. | Calculate the net present value and profitability index for each project based on a 10 percent cost of capital. Which, if either, of the project is acceptable? | |||
NPV (M) = | ||||
PI (M) = | ||||
NPV (O) = | ||||
PI (O) = | ||||
c. | Determine the internal rate of return and modified internal rate of return for Projects M and O. | |||
IRR (M): | ||||
IRR (O): | ||||
MIRR calculation of project M: | ||||
MIRR calculation of project O: |
Understanding the NPV Profile
1. If an independent project with conventional, or normal cash flows is being analyzed, the net present value (NPV) & internal rate of return (IRR) methods _______ agree.
A. Always
B. Never
C. Sometime
Projects W & X are mutually exclusive projects. Their cash flows & NPV profiles are shown as follows:
Year | Project W | Project X |
0 | $-1,500 | $-1,500 |
1 | $200 | $900 |
2 | $350 | $600 |
3 | $600 | $300 |
4 | $1000 | $200 |
2. If the required rate of return for each project is 2%, do the NPV & IRR methods agree or conflict?
A. The methods agree
B. The methods conflict
A Key to resolving this conflict is the assumed reinvestment rate.
3. The NPV calculation implicitly assumes that intermediate cash flows are reinvested at the?
A. Modified rate of return (MIRR)
B. Required rate of return
C. Internal rate of return (IRR)
4. The IRR calculation assumes that the rate at which cash flows can be reinvested is the?
A. Modified rate of return (MIRR)
B. Required rate of return
C. Internal rate of return (IRR)
5. As a result, when evaluating mutually exclusives projects, the ________ is usually the better decision criterion.
A. IRR method
B. NPV method