1a. Why might a financial analyst use the NPV method formaking project decisions instead of the IRR method?
------------------
1b. Explain the reinvestment rate assumption in thecontext of a projectâs cash flows over time.
------------------
1c. When we create NPV profiles, what variable is on they-axis and what variable is on the x-axis?
------------------
1d. Suppose a firmâs WACC exceeds the IRR for bothprojects L and S, if the projects are mutually exclusive, whichproject should the firm invest in? What if the projects are notmutually exclusive, then which project(s) should the firm investin? (Hint: If the WACC is greater than both projectsâ IRR, thenboth projects would delivery negative NPV.)
1a. Why might a financial analyst use the NPV method formaking project decisions instead of the IRR method?
------------------
1b. Explain the reinvestment rate assumption in thecontext of a projectâs cash flows over time.
------------------
1c. When we create NPV profiles, what variable is on they-axis and what variable is on the x-axis?
------------------
1d. Suppose a firmâs WACC exceeds the IRR for bothprojects L and S, if the projects are mutually exclusive, whichproject should the firm invest in? What if the projects are notmutually exclusive, then which project(s) should the firm investin? (Hint: If the WACC is greater than both projectsâ IRR, thenboth projects would delivery negative NPV.)
Related questions
Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 12%.
| 0 | 1 | 2 | 3 | 4 | ||||||
| Project A | -1,110 | 790 | 350 | 250 | 300 | |||||
| Project B | -1,110 | 390 | 285 | 400 | 750 | |||||
What is Project Aâs IRR? Do not round intermediate calculations. Round your answer to two decimal places.
%
What is Project B's IRR? Do not round intermediate calculations. Round your answer to two decimal places.
%
If the projects were independent, which project(s) would be accepted according to the IRR method?
-Select-NeitherProject AProject BBoth Projects A and BCorrect 1 of Item 3
If the projects were mutually exclusive, which project(s) would be accepted according to the IRR method?
-Select-Neither Project AProject BBoth Projects A and BCorrect 2 of Item 3
Could there be a conflict with project acceptance between the NPV and IRR approaches when projects are mutually exclusive?
-Select-YesNoCorrect 3 of Item 3
The reason is -Select-the NPV and IRR approaches use the same reinvestment rate assumption so both approaches reach the same project acceptance when mutually projects are considered.the NPV and IRR approaches use different reinvestment rate assumptions so there can be a conflict in project acceptance when mutually exclusive projects are considered.Correct 4 of Item 3
Reinvestment at the -Select-IRRWACCCorrect 5 of Item 3 is the superior assumption, so when mutually exclusive projects are evaluated the -Select-NPVIRRCorrect 6 of Item 3 approach should be used for the capital budgeting decision.
NPV profiles: timing differences
An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $12.6 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $15.12 million. Under Plan B, cash flows would be $2.2389 million per year for 20 years. The firm's WACC is 12.2%.
a. Construct NPV profiles for Plans A and B. Round your answers to two decimal places. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55.
| Discount Rate | NPV Plan A | NPV Plan B |
| 0% | $ _____million | $ _____million |
| 5 | $ _____million | $ _____million |
| 10 | $ _____million | $ _____million |
| 12 | $ _____million | $ _____million |
| 15 | $ _____million | $ _____million |
| 17 | $ _____million | $ _____million |
| 20 | $ _____million | $ _____million |
Identify each project's IRR. Round your answers to two decimal places.
Project A _____ %
Project B______ %
Find the crossover rate. Round your answer to two decimal places.
_____%
b. Is it logical to assume that the firm would take on all available independent, average-risk projects with returns greater than 12.2%? Yes or No
If all available projects with returns greater than 12.2% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12.2%, because all the company can do with these cash flows is to replace money that has a cost of 12.2%? Yes or No
Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows? Yes or No
Your first assignment in your new position as assistant financial analyst at Caledonia Products is to evaluate two new capital-budgeting proposals. Because this is your first assignment, you have been asked not only to provide a recommendation but also to respond to a number of questions aimed at assessing your understanding of the capital-budgeting process. This is a standard procedure for all new financial analysts at Caledonia, and it will serve to determine whether you are moved directly into the capital-budgeting analysis department or are provided with remedial training. The memorandum you received outlining your assignment follows:
To: The New Financial Analysts
From: Mr. V. Morrison, CEO, Caledonia Products
Re: Capital-Budgeting Analysis
Provide an evaluation of two proposed projects, both with 5-year expected lives and identical initial outlays of
$110,000. Both of these projects involve additions to Caledoniaâs highly successful Avalon product line, and as
a result, the required rate of return on both projects has been established at 12 percent. The expected free cash
flows from each project are as follows:
| Project A | Project B | ||
| Initial outlay | -$110,000 | -$110,000 | |
| Inflow year 1 | 20,000 | 40,000 | |
| Inflow year 2 | 30,000 | 40,000 | |
| Inflow year 3 | 40,000 | 40,000 | |
| Inflow year 4 | 50,000 | 40,000 | |
| Inflow year 5 | 70,000 | 40,000 |
In evaluating these projects, please respond to the following questions. For questions from (a) to (j) assume that the projects are independent. That is both could be accepted if both are acceptable.
a. What is the payback period on each project? If Caledonia imposes a 3-year maximum acceptable payback period, which of these projects should be accepted?
b. What are the criticisms of the payback period?
c. Determine the NPV for each of these projects. Should they be accepted?
d. Describe the logic behind the NPV.
e. Determine the PI for each of these projects. Should they be accepted?
f. Would you expect the NPV and PI methods to give consistent accept/reject decisions? Why or why not?
g. Determine the IRR for each project. Should they be accepted?
h. What reinvestment rate assumptions are implicitly made by the NPV and IRR methods? Which one is better?
i. Determine the MIRR for each project. Should they be accepted?
j. Describe the logic behind the MIRR.
k. Rank the two project based on all above criteria and make a recommendation as to which (if either) should be
accepted under the assumption that the projects are mutually exclusive.
l. Caledonia is considering two additional mutually exclusive projects. The free cash flows associated with these projects are as follows:
| Project A | Project B | ||
| Initial outlay | -$100,000 | -$100,000 | |
| Inflow year 1 | 32,000 | 0 | |
| Inflow year 2 | 32,000 | 0 | |
| Inflow year 3 | 32,000 | 0 | |
| Inflow year 4 | 32,000 | 0 | |
| Inflow year 5 | 32,000 | 200,000 |
The required rate of return on these projects is 11 percent.
1. What is each projectâs payback period?
2. What is each projectâs NPV?
3. What is each projectâs IRR?
4. What has caused the ranking conflict?
5. Which project should be accepted? Why?
I ONLY NEED TO DO PART l. (the last question) I need to answer questions 1-5
