Concept explainers
Consider a project with
a. What is the
b. Suppose that to raise the funds for the initial investment, the project is sold to investors as an all-equity firm. The equity holders will receive the cash flows of the project in one year. How much money can be raised in this way—that is, what is the initial market value of the unlevered equity?
c. Suppose the initial $110,000 is instead raised by borrowing at the risk-free interest rate. What are the cash flows of the levered equity in a weak market and a strong market at the end of year 1, and what is its initial market value of the levered equity according to MM? Assume that the risk-free rate remains at its current level and ignore any arbitrage opportunity.
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- Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown below. The required rate of return on projects of both of their risk class is 8 percent, and that the maximum allowable payback and discounted payback statistic for the projects are 2 and 3 years, respectively. Time Project A Cash Flow Project B Cash Flow Use the payback decision rule to evaluate these projects, which one(s) should it be accepted or rejected? Multiple Choice 0 -35,000 -45,000 1 25,000 25,000 2 45,000 5,000 3 16,000 65,000arrow_forwardSuppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 11 percent, and that the maximum allowable payback and discounted payback statistics for your company are 3.0 and 3.5 years, respectively. Time: Cash flow: 0 1 2 -$241,000 $66,400 $84,600 Payback Use the payback decision rule to evaluate this project. Note: Round your answer to 2 decimal places. years 4 3 $141,600 $122,600 Should the project be accepted or rejected? (Click to select) 5 $81,800arrow_forwardSoft and Cuddly is considering a new toy that will produce the following cash flows. Should the company produce this toy based on IRR if the firm requires a rate of return of 17.5 percent? Yes, because the project's rate of return is 16.45 percent Yes, because the project's rate of return is 11.47 percent No, because the project's rate of return is 16.45 percent No, because the project's rate of return is 11.47 percent No, because the internal rate of return is zero percentarrow_forward
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- Which of the following statements is incorrect regarding project appraisal techniques? At IRR, the NPV of a project is equal to 0 If the IRR of a project is 8%, its NPV calculated using a discount rate greater than 8%, will be less than 0 If the NPV of a project is greater than 0, then its PI will exceed 1. If the PI of a project equals 0, then the project's initial cash outflow equals the PV of its cash inflowsarrow_forwardSuppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 12 percent, and that the maximum allowable payback and discounted payback statistic for the project are 2 and 3 years, respectively. Time 0 1 2 3 4 5 6 Cash Flow -1,150 30 570 770 770 370 770 Use the NPV decision rule to evaluate this project; should it be accepted or rejected? Multiple Choice A. $968.66, accept B. $2,118.66, accept C. $-495.13, reject D. $864.87, acceptarrow_forwardZLY calculates that a project with conventional cash flows and a required return of 14% has a negative NPV. What do we then know about the project's internal rate of return? A) equal to 21% B) greater than 14% C) less than 14% D) equal to zeroarrow_forward
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