FINE 2000 Chapter Notes -Discounted Cash Flow, Net Present Value, Cash Flow

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7 Mar 2013

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Ch 7 - npv and other investment criteria. 7. 2 other investment criteria payback period - time until cash flows recover the initial investment of the project. The payback rule states that a project should be accepted if its payback period is less than a specified cutoff period. Payback does not consider any cash flows that arrive after the payback period. This could result in two different projects being accepted, although only one might have a positive npv. Second problem is that payback gives equal weight to all cash flows arriving before the cutoff period despite the fact that the more distant flows are less valuable. The payback rule will bias the firm against accepting long-term projects because cash flows arriving after payback period are ignored. In spite of these problems, payback is widely used for its simplicity and ability to communicate throughout a firm. Npv profile: npv plotted for a variety of discount rates.

Related Questions

Calculating Payback. Global Toys Inc., imposes a payback cutoff of three years for its international investment projects. If the company has the following two projects available, should it accept either of them?

Year Cash Flow (A) Cash Flow (B)
0 â$55,000 â$ 95,000
1 19,000 18,000
2 27,000 26,000
3 24,000 28,000
4 9,000 260,000

Which Project should be accepted A or B?

a. The payback for Project A is: Payback =

b. The payback for Project B is: Payback =

c. Which project should be accepted:

____________________________________
Calculating AAR. Youâre trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $14 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $1,253,000, $1,935,000, $1,738,000, and $1,310,000 over these four years, what is the projectâs average accounting return (AAR)?

Calculating AAR, the average net income divided by the average book value. (Show work by calculating net income and average book value):

a. Average net income =

b. Average book value =

c. AAR =

_________________________________________

Calculating IRR. A firm evaluates all of its projects by applying the IRR rule. If the required return is 11 percent, should the firm accept the following project?

Year Cash Flow
0 â$153,000
1 78,000
2 67,000
3 49,000

Calculating IRR the interest rate that makes the NPV of the project equal to zero. (Show work by calculating IRR):

a. IRR =

b. Should the project be accepted and why?

________________________________

Calculating NPV. For the cash flows in the previous problem, suppose the firm uses the NPV decision rule. At a required return of 9 percent, should the firm accept this project? What if the required return was 21 percent?

Calculating NPV. Hint the NPV of a project is the PV of the outflows minus by the PV of the inflows. (Show work by calculating NPV):

a. @ 9% required return.

NPV@ 9% required return =

b. Should the project be accepted:

c. @ 21% required return.

NPV@ 21% required return =

d. Should the project be accepted:

orangecricket262

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

skybeaver388

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:

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.

FINE 2000 Chapter Notes -Discounted Cash Flow, Net Present Value, Cash Flow

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