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Chapter 4 - Concept Questions and Exercises

This document contains 10 concept questions and exercises related to corporate finance topics including calculating payback period, net present value, internal rate of return, profitability index, and comparing investment criteria. The questions provide cash flow information for various investment projects and ask the reader to determine which projects should be chosen based on different evaluation methods, what the internal rates of return are for projects, and how to rank projects based on profitability index and net present value.

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Tranh Meow Meow
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66 views5 pages

Chapter 4 - Concept Questions and Exercises

This document contains 10 concept questions and exercises related to corporate finance topics including calculating payback period, net present value, internal rate of return, profitability index, and comparing investment criteria. The questions provide cash flow information for various investment projects and ask the reader to determine which projects should be chosen based on different evaluation methods, what the internal rates of return are for projects, and how to rank projects based on profitability index and net present value.

Uploaded by

Tranh Meow Meow
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Concept Questions and Exercises CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe

CHAPTER 4
INVESTMENT CRITERIAS
https://www.studocu.com/en-us/document/university-of-scranton/case-course-in-corporate-
finance/week-4-assignment/13165792
1. Calculating Payback Period and NPV Maxwell Software, Inc., has the following mutually
exclusive projects.

a. Suppose the company’s payback period cutoff is two years. Which of these two projects should
be chosen?
b. Suppose the company uses the NPV rule to rank these two projects. Which project should be
chosen if the appropriate discount rate is 15 percent?
2. Calculating Discounted Payback An investment project has annual cash inflows of $5,000,
$5,500, $6,000, and $7,000, and a discount rate of 12 percent. What is the discounted payback
period for these cash flows if the initial cost is $8,000? What if the initial cost is $12,000? What if it
is $16,000?
3. Calculating IRR Compute the internal rate of return for the cash flows of the following two
projects:

4. Calculating Profitability Index Bill plans to open a self-serve grooming center in storefront.
The grooming equipment will cost $265,000, to be paid immediately. Bill expects aftertax cash
inflows of $59,000 annually for seven years, after which he plans to scrap the equipment and retire
to the beaches of Nevis. The first cash inflow occurs at the end of the first year. Assume the
required return is 13 percent. What is the project’s PI? Should it be accepted?
5. NPV versus IRR Consider the following cash flows on two mutually exclusive projects for the
Bahamas Recreation Corporation (BRC). Both projects require an annual return of 14 percent.
Concept Questions and Exercises CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe

b
As a financial analyst for BRC, you are asked the following questions:
a. If your decision rule is to accept the project with the greater IRR, which project should you
choose?

Hơn 14% thì accept


b. Because you are fully aware of the IRR rule’s scale problem, you calculate the incremental IRR
for the cash flows. Based on your computation, which project should you choose?
Concept Questions and Exercises CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe

c. To be prudent, you compute the NPV for both projects. Which project should you choose? Is it
consistent with the incremental IRR rule?

6. Comparing Investment Criteria Wii Brothers, a game manufacturer, has a new idea for an
adventure game. It can market the game either as a traditional board game or as an interactive DVD,
but not both. Consider the following cash flows of the two mutually
exclusive projects for the company. Assume the discount rate for both projects is 10 percent.
Concept Questions and Exercises CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe

a. Based on the payback period rule, which project should be chosen?


b. Based on the NPV, which project should be chosen?
c. Based on the IRR, which project should be chosen?
d. Based on the incremental IRR, which project should be chosen?
7. Profitability Index versus NPV Hanmi Group, a consumer electronics conglomerate, is
reviewing its annual budget in wireless technology. It is considering investments in three different
technologies to develop wireless communication devices. Consider the following cash flows of the
three independent projects available to the company. Assume the discount rate for all projects is 10
percent. Further, the company has only $40 million to invest in new projects this year.

a. Based on the profitability index decision rule, rank these investments.


b. Based on the NPV, rank these investments.
c. Based on your findings in (a) and (b), what would you recommend to the CEO of the company
and why?
8. NPV and Multiple IRRs You are evaluating a project that costs $75,000 today. The project has
an inflow of $155,000 in one year and an outflow of $65,000 in two years. What are the IRRs for
the project? What discount rate results in the maximum NPV for this project? How can you
determine that this is the maximum NPV?
9. Payback and NPV An investment under consideration has a payback of six years and a cost of
$573,000. If the required return is 12 percent, what is the worst-case NPV? The best-case NPV?
Explain. Assume the cash flows are conventional.
10. Calculating IRR Consider two streams of cash flows, A and B. Stream A’s first cash flow is
$11,600 and is received three years from today. Future cash flows in Stream A grow by 4 percent in
Concept Questions and Exercises CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe

perpetuity. Stream B’s first cash flow is 2$13,000, is received two years from today, and will
continue in perpetuity. Assume that the appropriate discount rate is 12 percent.
a. What is the present value of each stream?
b. Suppose that the two streams are combined into one project, called C. What is the IRR
of Project C?
c. What is the correct IRR rule for Project C ?

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