Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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Consider the following two sets of project cash flows:
Project Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Discount
Rate
X -903 175.6 169.8 201.4 251.5 299.2 305.2 0.1037
Y -513 190.5 195.5 90.5 80.5 85.5 110.5 0.1037
A) Assume that projects X and Y are mutually exclusive. The correct investment decision and
the best rational for that decision is to:
i) invest in Project Y since IRRY > IRRX.
ii) invest in Project Y since NPVY > NPVX.
iii) neither of the above.
B) What are the incremental
C) Is the use of the incremental measures in B) appropriate to your evaluation of the
preferred project? Explain.
D) Which is the preferred project? Explain and justify the basis for your choice.
(6 marks)
2) Due to the demands of the new ATO Single Tough Reporting System, a successful manufacturing
company is assessing the introduction of a new computer system to improve regulatory reporting
compliance. The managing director wants to install a new Pay Perfect system, whereas the Chief
Financial Officer prefers the Complete Pay system. Each system provides the same recordkeeping ability, and can provide the required information to the Tax Office. The initial cost of each
system is $15,000, but because of differing software, maintenance, and processing requirements,
estimates of the after-tax costs of operation differ. These are as follows:
Period Pay
Perfect
Complete
Pay
1 3,800 5,500
2 4,900 6,000
3 4,900 6,300
4 4,900 6,300
5 4,900 5,100
6 4,900
7 4,500
The firm has an after tax weighted cost of capital of 11.45 per cent.
A) Can you determine the IRR for each project? Explain.
B) Determine the NPV for each project. Which project does NPV suggest you recommend?
C) Is NPV the correct tool with which to make your recommendations? Explain.
D) Using an appropriate method, determine which system you would recommend to the
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- 4. Modified internal rate of return (MIRR) The IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR. However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the project's IRR. Consider the following situation: Grey Fox Aviation Company is analyzing a project that requires an initial investment of $3,225,000. The project's expected cash flows are: Year Cash Flow Year 1 Year 2 Year 3 Year 4 Grey Fox Aviation Company's WACC is 8%, and the project has the same risk as the firm's average project. Calculate this project's modified internal rate of return (MIRR): 16.25% 13.69% $325,000 -150,000 450,000 475,000 14.54% -20.05% If Grey Fox Aviation Company's managers select projects based on the MIRR criterion, they should Which of the following statements about the relationship between the IRR and the MIRR is…arrow_forwardA project's present value can be decreased by, I. decreasing the required discount rate (required return) II. decreasing the amount of the final cash inflow II. increasing the project's initial cost at time zero IV. moving each of the cash inflows to a more distant time period V. increasing the value of each of the project's discounted cash inflowsarrow_forwardModified internal rate of return (MIRR) The IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR. However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the project’s IRR. Consider the following situation: Grey Fox Aviation Company is analyzing a project that requires an initial investment of $2,225,000. The project’s expected cash flows are: Year Cash Flow Year 1 $325,000 Year 2 –100,000 Year 3 475,000 Year 4 475,000 Q1. Grey Fox Aviation Company’s WACC is 9%, and the project has the same risk as the firm’s average project. Calculate this project’s modified internal rate of return (MIRR): 33.79% 29.18% -11.55% 27.65% If Grey Fox Aviation Company’s managers select projects based on the MIRR criterion, they should Q2. ______ this…arrow_forward
- The net present value is ... O A. The return which is required for an investment O B. The current worth of a future stream of cash O C. The length of time it takes to recover the initial investment of a project O D. The sum of a time series of discounted cash inflows and outflowsarrow_forwardWhich of the statements below is TRUE regarding capital budgeting? O A. Capital budgeting deals with how much to apportion spending on current assets. O B. Projects with NPVS greater than the IRR should be accepted. OC. We can find a project's NPV by simply taking the product of all of the project's undiscounted cash flows. O D. Ceteris paribus, a lower cost of capital would increase a project's NPV.arrow_forwardConsider the two mutually exclusive projects described in the table below. the question requires a step by step excel solutionFor any positive value of the MARR, divide the possible MARR values into ranges with different decisions;describe and discuss what decision would be made in each range and why. You will need to calculate the crossover rate to determine the precise MARR where the decision changes. Include an NPV profile table and chart to illustrate your answer.Year Cash Flow Project A Cash Flow Project B0 -450,000 -700,0001 200,000 200,0002 150,000 200,0003 100,000 200,0004 100,000 200,0005 75,000 200,000arrow_forward
- Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one cash outflow at t = o followed by a series of positive cash flows. a. To find a project's MIRR, we compound cash inflows at the regular IRR and then find the discount rate that causes the PV of the terminal value to equal the initial cost. b. To find a project's MIRR, the textbook procedure compounds cash inflows at the WACC and then finds the discount rate that causes the PV of the terminal value to equal the initial cost. c. A project's MIRR is always greater than its regular IRR. d. If a project's IRR is greater than its WACC, then its MIRR will be greater than the IRR. e. A project's MIRR is always less than its regular IRR.arrow_forwardWhich one of the following statements is correct concerning the payback rule? a. The payback period is computed using the present value of each of the cash flows. b. The rule says that you should accept a project if the payback period is greater than 1.0. c. The rule is biased in favour of long-term projects. d. The rule is flawed because it ignores all cash flows after some arbitrary point in time.arrow_forwardConsider the cash flows for the investment projects given in Table. Assume that the MARR = 10%. (a) Suppose A, B, and C are mutually exclusive projects. Which project would be selected on the basis of the IRR criterion? (b) Assume that projects C and E are mutually exclusive. Using the IRR criterion, which Project would you select?. Net Cash Flow B D. E -4,850 2,100 2,100 2,500 4,250 3,200 2,850 800 300 4,250 4,250 2,850 2,900 1,050 500 -835 -835 -835 -835 1,500 3.250 1,600 1,200 2,100 2,100arrow_forward
- Consider two mutually exclusive projects, A and B, whose costs and cash flows areshown in the following table:Year Project A Project B1 $(14,000) $(22,840)2 8,000 8,0003 6,000 8,0004 2,000 8,0005 3,000 8,000Calculate the cross over rate. Please use equations and not excelarrow_forwardWhen you are evaluating independent projects and the projects' cash flows are conventional, the IRR and NPV methods will always agree. O No answer text provided. O No answer text provided. O False Truearrow_forward4. Modified internal rate of return (MIRR) The IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR. However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the project’s IRR. Consider the following situation: Green Caterpillar Garden Supplies Inc. is analyzing a project that requires an initial investment of $500,000. The project’s expected cash flows are: Year Cash Flow Year 1 $300,000 Year 2 –100,000 Year 3 450,000 Year 4 450,000 Green Caterpillar Garden Supplies Inc.’s WACC is 9%, and the project has the same risk as the firm’s average project. Calculate this project’s modified internal rate of return (MIRR): 22.81% 18.25% 21.67% 20.53%arrow_forward
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