BUSFIN 3120 Lecture Notes - Lecture 22: Net Present Value

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copperalpaca176

1 Nov 2018

School

Ohio State University

Department

Business Admin : Finance

Course

BUSFIN 3120

Professor

Taner Pirim

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Document Summary

12:42 pm: cash flows that change signs more than once throughout the life of project, have more than one irr, example: *to use irr method, you need to convert nonconventional cash flows to conventional. Method 1: discounting approach: discount all future outflows (negative cash flows) to present and add to initial investment (cf0, zero out negative cashflows, compute irr, -112,697=-112,697= - Method 2: reinvestment approach: compound all cfs to the end of the project except initial. Inv, cf0: zero-out all cfs compounded, yr 2- 100,000(1+0. 1)^1, yr 1- 132,000(1+0. 1)^2, npv=0=119,720/(1+mi. Method 3: combination approach: discount all outflows to present and add to cfs, compound all inflows to the end, zero-out the compounded/discounted cfs, yr 3- - Profitability index: measures the benefit per unit cost based on the time value of money, pi=npv/resources consumed= npv/initial. If<0 do not accept: exp: mateo"s project has projected cash flows of ,600, ,400, and ,800 over its three year life.

Related Questions

Problem 11-14
Choosing mandatory projects on the basis of least cost

Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise, the highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low capital costs, respectively). HCC has a high capital cost but relatively low operating costs, while LCC has a low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown here. Kim's WACC is 6%.

HCC	-$600,000	-$45,000	-$45,000	-$45,000	-$45,000	-$45,000
LCC	-$100,000	-$180,000	-$180,000	-$180,000	-$180,000	-$180,000

Which unit would you recommend?

1. Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV.

2. Since all of the cash flows are negative, the IRR's will be negative and we do not accept any project that has a negative IRR.

3. Since we are examining costs, the unit chosen would be the one that had the lower NPV of costs. Since LCC's NPV of costs is lower than HCC's, LCC would be chosen.

4. Since we are examining costs, the unit chosen would be the one that had the lower NPV of costs. Since HCC's NPV of costs is lower than LCC's, HCC would be chosen.

5. Since all of the cash flows are negative, the NPV's cannot be calculated and an alternative method must be employed.

Answer ___________

If Kim's controller wanted to know the IRRs of the two projects, what would you tell him?

1. There are multiple IRR's for each project.

2. The IRR of each project is negative and therefore not useful for decision-making.

3. The IRR cannot be calculated because the cash flows are all one sign. A change of sign would be needed in order to calculate the IRR.

4. The IRR cannot be calculated because the cash flows are in the form of an annuity.

5. The IRR of each project will be positive at a lower WACC.

Answer ___________

If the WACC rose to 12% would this affect your recommendation?

1. When the WACC increases to 12%, the NPV of costs are now lower for HCC than LCC.

2. When the WACC increases to 12%, the IRR for LCC is greater than the IRR for HCC, LCC would be chosen.

3. When the WACC increases to 12%, the IRR for HCC is greater than the IRR for LCC, HCC would be chosen.

4. Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV.

5. When the WACC increases to 12%, the NPV of costs are now lower for LCC than HCC.

Answer ___________

Explain your answer and the reason this result occurred.

The reason is that when you discount at a higher rate you are making negative CFs smaller thus improving the NPV.

The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the IRR.

The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the NPV.

The reason is that when you discount at a higher rate you are making negative CFs higher and this lowers the NPV.

The reason is that when you discount at a higher rate you are making negative CFs smaller and this lowers the NPV.

tealbuffalo667

Choosing mandatory projects on the basis of least cost

HCC	-$590,000	-$55,000	-$55,000	-$55,000	-$55,000	-$55,000
LCC	-$110,000	-$175,000	-$175,000	-$175,000	-$175,000	-$175,000

Which unit would you recommend?

Since we are examining costs, the unit chosen would be the one that had the lower PV of costs. Since LCC's PV of costs is lower than HCC's, LCC would be chosen.

Since we are examining costs, the unit chosen would be the one that had the lower PV of costs. Since HCC's PV of costs is lower than LCC's, HCC would be chosen.

Since all of the cash flows are negative, the IRR's will be negative and we do not accept any project that has a negative IRR.

Since all of the cash flows are negative, the NPV's cannot be calculated and an alternative method must be employed.

Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV.

-Select-IIIIIIIVVItem 1
If Kim's controller wanted to know the IRRs of the two projects, what would you tell him?

The IRR cannot be calculated because the cash flows are all one sign. A change of sign would be needed in order to calculate the IRR.

The IRR cannot be calculated because the cash flows are in the form of an annuity.

The IRR of each project will be positive at a lower WACC.

There are multiple IRR's for each project.

The IRR of each project is negative and therefore not useful for decision-making.

-Select-IIIIIIIVVItem 2
If the WACC rose to 14% would this affect your recommendation?

When the WACC increases to 14%, the IRR for LCC is greater than the IRR for HCC, LCC would be chosen.

When the WACC increases to 14%, the IRR for HCC is greater than the IRR for LCC, HCC would be chosen.

Since all of the cash flows are negative, the NPV's will be negative and we do not accept any project that has a negative NPV.

When the WACC increases to 14%, the PV of costs are now lower for LCC than HCC.

When the WACC increases to 14%, the PV of costs are now lower for HCC than LCC.

-Select-IIIIIIIVVItem 3

Explain your answer and why this result occurred.

The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the IRR.

The reason is that when you discount at a higher rate you are making negative CFs higher thus improving the NPV.

The reason is that when you discount at a higher rate you are making negative CFs higher and this lowers the NPV.

The reason is that when you discount at a higher rate you are making negative CFs smaller and this lowers the NPV.

The reason is that when you discount at a higher rate you are making negative CFs smaller thus improving the NPV.

-Select-IIIIIIIVV

Choosing mandatory projects on the basis of least cost

HCC	-$610,000	-$45,000	-$45,000	-$45,000	-$45,000	-$45,000
LCC	-$110,000	-$170,000	-$170,000	-$170,000	-$170,000	-$170,000