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FIN 300 Study Guide - Payback Period, Cash Flow, Net Present Value

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School
Ryerson University
Department
Finance
Course
FIN 300
Professor
Scott Anderson

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Document Summary

Answers to concepts review and critical thinking questions. A payback period less than the project"s life means that the npv is positive for a zero discount rate, but nothing more definitive can be said. The discounted payback includes the effect of the relevant discount rate. If a project"s discounted payback period is less than the project"s life, it must be the case that npv is positive. If a project has a positive npv for a certain discount rate, then it will also have a positive npv for a zero discount rate; thus, the payback period must be less than the project life. Since discounted payback is calculated at the same discount rate as is npv, if npv is positive, the discounted payback period must be less than the project"s life. If npv is positive, then the present value of future cash inflows is greater than the initial investment cost; thus pi must be greater than 1.

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Related Questions

Quiz 1

Net Present Value

0 1 2 3 4 5

| | | | | |

-750 200 100 300 400 200

Discount Rate = 7%

a, Calculate the NPV (2 points)

b, Calculate the IRR.(1 point)

c, Should the project be accepted?Explain your answer by discussingNPV and IRR. (1 point)

d,Circle the correct answer.When calculating NPV, The HIGHER/LOWER the discount rate,the higher the NPV.(1 point)

e, Calculate the Payback Period for this Project.(2 points)

f, Calculate the Profitability Index for this project.(2 points)

g,Circle the correct answer.In general, the payback period of a project should be Greater/Less than the discounted payback period for that project. (1 point)

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?

You are considering the following two mutually exclusive projects. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value

Year

Project(A)

Project (B)

0

-$30,000

-$25,000

1

10,000

8,000

2

11,000

8,000

3

12,000

8,000

4

13,000

8,000

The required rate of return is 10%.

(a) What is the NPV for each of the projects? Which project should be accepted if NPV method is applied? Explain why.

(b) What is the IRR for each of the projects? Which project should be accepted if IRR method is applied? Explain why.

(c) What is the payback period for each of the projects? Which project should be accepted if payback period method is applied? Explain why.

(d) What is the discounted payback period for each of the projects? Which project should be accepted if discounted payback period method is applied? Explain why.

(e) What is the profitability index for each of the projects? Which project should be accepted if profitability index method is applied? Explain why.

(f) Find the crossover rate. Show the equation.

(g) Sketch the NPV profile. You must plot at least 5 points for the profile: two points on the x and y axis each, and the cross-over rate on the x axis.