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FIN 401 Lecture Notes - Lecture 3: Sunk Costs, Preferred Stock, Capital Budgeting

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violetrat231
6 Dec 2016
School
Ryerson University
Department
Finance
Course
FIN 401
Professor
Michael Jolly

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Document Summary

Npv= present value of discounted cash flows. positive = accept. Npv is best way to make a decision. Irr: (cid:449)e"(cid:396)e spe(cid:374)di(cid:374)g (cid:373)o(cid:374)e(cid:455) toda(cid:455) that (cid:449)ill (cid:271)(cid:396)i(cid:374)g futu(cid:396)e (cid:272)ash flo(cid:449)s, (cid:449)e use those (cid:272)ash flo(cid:449)s to figu(cid:396)e out what the rate is. The irr is the discount rate that makes npv = 0. Accept if irr is greater than required return. The bigger the discount rate means npv will be lower. Unconventional cash flows: irr may choose to reject, when npv could chose to accept. There is an additional irr due to the bell curved cash flows. Irr cannot be used with unconventional cash flows (positive and negative cash flows). Crossover rate: the discount rate at which you are indifferent about the project selection. Put the difference of cash flows into the calc. Compute irr : 11. 8% is the crossover rate. At 11. 8% discount rate, the npv would be the same for both projects.

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Related Questions

Capital budgeting criteria

A firm with a 13% WACC is evaluating two projects for this year's capital budget. After-tax cash flows, including depreciation, are as follows:

0 1 2 3 4 5

Project A -$12,000 $4,000 $4,000 $4,000 $4,000 $4,000
Project B -$36,000 $11,200 $11,200 $11,200 $11,200 $11,200

Calculate NPV for each project. Round your answers to the nearest cent.
Project A $
Project B $

Calculate IRR for each project. Round your answers to two decimal places.
Project A %
Project B %

Calculate MIRR for each project. Round your answers to two decimal places.
Project A %
Project B %

Calculate payback for each project. Round your answers to two decimal places.
Project A years
Project B years

Calculate discounted payback for each project. Round your answers to two decimal places.
Project A years
Project B years

Assuming the projects are independent, which one or ones would you recommend?
-Select-
Only Project B would be accepted because NPV(B) > NPV(A).
Both projects would be accepted since both of their NPV's are positive.
Only Project A would be accepted because IRR(A) > IRR(B).
Both projects would be rejected since both of their NPV's are negative.
Only Project A would be accepted because NPV(A) > NPV(B).
Item 11

If the projects are mutually exclusive, which would you recommend?
-Select-
If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project A.
If the projects are mutually exclusive, the project with the highest positive MIRR is chosen. Accept Project A.
If the projects are mutually exclusive, the project with the shortest Payback Period is chosen. Accept Project A.
If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project B.
If the projects are mutually exclusive, the project with the highest positive NPV is chosen. Accept Project B.
Item 12

Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?
-Select-
The conflict between NPV and IRR is due to the relatively high discount rate.
The conflict between NPV and IRR is due to the fact that the cash flows are in the form of an annuity.
The conflict between NPV and IRR is due to the difference in the timing of the cash flows.
There is no conflict between NPV and IRR.
The conflict between NPV and IRR occurs due to the difference in the size of the projects.
Item 13

Year/Project A/ProjectB

1$ (43,500.00)$ (43,500.00)

2 $ 21,400.00 $ 6,400.00

3 $ 18,500.00 $ 14,700.00

4 $ 13,800.00 $ 22,800.00

5 $ 7,600.00 $ 25,200.00

1. Using the above cash flows, calculate the following for each project. Assume a 11% required return a. NPV b. Payback Period c. Discounted Payback Period d. IRR e. MIRR (Combination Approach: Use discount rate given and reinvestment rate of 8%) 2. Assuming independent projects, provide an accept/reject decision for each capital budgeting tool a. Assume payback period criteria is 2.5 years b. Assume discounted payback period criteria is 3 years 3. Assuming mutually exclusive projects, which project should be selected? Why?

Capital budgeting criteria

A firm with a 14% WACC is evaluating two projects for this year's capital budget. After-tax cash flows, including depreciation, are as follows:

0 1 2 3 4 5
Project M -$6,000 $2,000 $2,000 $2,000 $2,000 $2,000
Project N -$18,000 $5,600 $5,600 $5,600 $5,600 $5,600

Calculate NPV for each project. Round your answers to the nearest cent. Do not round your intermediate calculations.
Project M $
Project N $

Calculate IRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M %
Project N %

Calculate MIRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M %
Project N %

Calculate payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M years
Project N years

Calculate discounted payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M years
Project N years

Assuming the projects are independent, which one(s) would you recommend?
-Select-Both projects would be accepted since both of their NPV's are positive.Only Project M would be accepted because IRR(M) > IRR(N).Both projects would be rejected since both of their NPV's are negative.Only Project M would be accepted because NPV(M) > NPV(N).Only Project N would be accepted because NPV(N) > NPV(M).Item 11

If the projects are mutually exclusive, which would you recommend?
-Select-If the projects are mutually exclusive, the project with the shortest Payback Period is chosen. Accept Project M.If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project N.If the projects are mutually exclusive, the project with the highest positive NPV is chosen. Accept Project N.If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project M.If the projects are mutually exclusive, the project with the highest positive MIRR is chosen. Accept Project M.Item 12

Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?
-Select-The conflict between NPV and IRR occurs due to the difference in the size of the projects.The conflict between NPV and IRR is due to the relatively high discount rate.The conflict between NPV and IRR is due to the fact that the cash flows are in the form of an annuity.The conflict between NPV and IRR is due to the difference in the timing of the cash flows.There is no conflict between NPV and IRR.