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 Chapter 10
The Basics of Capital Budgeting:
Evaluating Cash Flows

ANSWERS TO END-OF-CHAPTER QUESTIONS

10-1 a. Capital budgeting is the whole process of analyzing projects and deciding whether
they should be included in the capital budget. This process is of fundamental
importance to the success or failure of the firm as the fixed asset investment decisions
chart the course of a company for many years into the future. The payback, or
payback period, is the number of years it takes a firm to recover its project
investment. Payback may be calculated with either raw cash flows (regular payback)
or discounted cash flows (discounted payback). In either case, payback does not
capture a project’s entire cash flow stream and is thus not the preferred evaluation
method. Note, however, that the payback does measure a project’s liquidity, and
hence many firms use it as a risk measure.

b. Independent projects can be accepted or rejected individually. Mutually exclusive

projects cannot be performed at the same time. We can choose either Project 1 or
Project 2, or we can reject both, but we cannot accept both projects.

c. The net present value (NPV) and internal rate of return (IRR) techniques are
discounted cash flow (DCF) evaluation techniques. These are called DCF methods
because they explicitly recognize the time value of money. NPV is the present value
of the project’s expected future cash flows (both inflows and outflows), discounted at
the appropriate cost of capital. NPV is a direct measure of the value of the project to
shareholders. The internal rate of return (IRR) is the discount rate that equates the
present value of the expected future cash inflows and outflows. IRR measures the rate
of return on a project, but it assumes that all cash flows can be reinvested at the IRR
rate.

d. The modified internal rate of return (MIRR) assumes that cash flows from all projects
are reinvested at the cost of capital as opposed to the project’s own IRR. This makes
the modified internal rate of return a better indicator of a project’s true profitability.
The profitability index is found by dividing the project’s PV of future cash flows by
its initial cost. A profitability index greater than 1 is equivalent to a positive NPV
project.

e. An NPV profile is the plot of a project’s NPV versus its cost of capital. The crossover
rate is the cost of capital at which the NPV profiles for two projects intersect.
 f. Capital projects with non-normal cash flows have a large cash outflow either
sometime during or at the end of their lives. A project has normal cash flows if one or
more cash outflows (costs) are followed by a series of cash inflows. A common
problem encountered when evaluating projects with non-normal cash flows is
multiple IRRs.

g. The hurdle rate is the project cost of capital, or discount rate. It is the rate used in
discounting future cash flows in the NPV method, and it is the rate that is compared
to the IRR. The mathematics of the NPV method imply that project cash flows are
reinvested at the cost of capital while the IRR method assumes reinvestment at the
IRR. Since project cash flows can be replaced by new external capital, which costs r,
the proper reinvestment rate assumption is the cost of capital, and thus the best capital
budget decision rule is NPV.

h. Not all projects maximize their NPV if operated over their engineering lives and
therefore it may be best to terminate a project prior to the end of its potential life. The
economic life is the number of years a project should be operated to maximize its
NPV, and is often less than the maximum potential life. Capital rationing occurs
when management places a constraint on the size of the firm’s capital budget during a
particular period.

10-2 Projects requiring greater investment or that have greater risk should be given more
detailed analysis in the capital budgeting process.

10-3 The NPV is obtained by discounting future cash flows, and the discounting process
actually compounds the interest rate over time. Thus, an increase in the discount rate has
a much greater impact on a cash flow in Year 5 than on a cash flow in Year 1.

10-4 This question is related to Question 10-3 and the same rationale applies. With regard to
the second part of the question, the answer is no; the IRR rankings are constant and
independent of the firm’s cost of capital.

10-5 The NPV and IRR methods both involve compound interest, and the mathematics of
discounting requires an assumption about reinvestment rates. The NPV method assumes
reinvestment at the cost of capital, while the IRR method assumes reinvestment at the
IRR. MIRR is a modified version of IRR that assumes reinvestment at the cost of capital.

10-6 Generally, the failure to employ common life analysis in such situations will bias the
NPV against the shorter project because it “gets no credit” for profits beyond its initial
life, even though it could possibly be “renewed” and thus provide additional NPV.
 SOLUTIONS TO END-OF-CHAPTER PROBLEMS

10-1 NPV = –$40,000 + $9,000[(1/I) – (1/(I × (1 + I)N)]

= –$40,000 + $9,000[(1/0.11) – (1/(0.11 × (1 + 0.11)7)]
= $2,409.77.

Financial calculator solution: Input CF0 = –40000, CF1 – 7 = 9000, I/YR = 11, and then
solve for NPV = $2,409.77.

10-2 Financial calculator solution: Input CF0 = –40000, CF1 – 8 = 9000, and then solve for
IRR = 12.84%.

10-3 MIRR: PV Costs = $40000.

FV Inflows:

PV FV
0 11% 1 2 3 4 5 6 7
| | | | | | | |
9,000 9,000 9,000 9,000 9,000 9,000 9,000
9,990
11,089
12,309
13,663
15,166
16,834
40,000 MIRR= 11.93% 88,049

Financial calculator: Obtain the FVA by inputting N = 7, I/YR = 11, PV = 0,

PMT = 9000, and then solve for FV = $87,049. The MIRR can be obtained by inputting
N = 7, PV = –40000, PMT = 0, FV = 88049, and then solving for I/YR = 11.93%.

10-4 PV = $9,000[(1/I) – (1/(I × (1 + I)N)]

= $9,000[(1/0.11) – (1/(0.11 × (1 + 0.11)7)]
= $42,410.

Financial calculator: Find present value of future cash flows by inputting N = 7,

I/YR = 11, PMT = –9000, FV = 0, then solve for PV = $42,410.

PI = PV of future cash flows/Initial cost

= $42,410/$40,000 = 1.06.
10-5
Year CF Cumulative CF
0 –40,000 –40,000
1 9,000 –31,000
2 9,000 –22,000
3 9,000 –13,000
4 9,000 –4,000
5 9,000 5,000
6 9,000 14,000
7 9,000 23,000

The cumulative cash flows turn positive in Year 5, so the payback will be 4 plus the part
of Year 5 that is required to return the investment:
Payback = 4 + ($4,000/$9,000) = 4.44 years.

Because the future cash flows are identical, we can also find the payback period by
dividing the cost by the cash flow: $40,000/$9,000 = 4.44 years.

10-6 The project’s discounted payback period is calculated as follows:

Discounted CF Cumulative
Year Annual CF (@11%) Discounted CF
0 –40,000 –40,000.00
1 9,000 8,108.11 (31,891.89)
2 9,000 7,304.60 (24,587.29)
3 9,000 6,580.72 (18,006.57)
4 9,000 5,928.58 (12,077.99)
5 9,000 5,341.06 (6,736.93)
6 9,000 4,811.77 (1,925.16)
7 9,000 4,334.93 2,409.77

$1,925.16
The discounted payback period is 6 + years, or 6.44 years.
$4,334.93
10-7 a. Project A:

Using a financial calculator, enter the following:

CF0 = –15000000
CF1 = 5000000
CF2 = 10000000
CF3 = 20000000
I = 10; NPV = $12,836,213.

Change I = 10 to I = 5; NPV = $16,108,952.

Change I = 5 to I = 15; NPV = $10,059,587.

Project B:

Using a financial calculator, enter the following:

CF0 = –15000000
CF1 = 20000000
CF2 = 10000000
CF3 = 6000000
I = 10; NPV = $15,954,170.

Change I = 10 to I = 5; NPV = $18,300,939.

Change I = 5 to I = 15; NPV = $13,897,838.

b. Using the data for Project A, enter the cash flows and solve for IRRA=43.97%. The
IRR is independent of the WACC, so IRR doesn’t change when the WACC changes.

Using the data for Project B, enter the cash flows and solve for IRRB = 82.03%. Again,
the IRR is independent of the WACC, so IRR doesn’t change when the WACC
changes.

10-8 Truck:

NPV = –$39,500 + $12,500(PVIFA14%,5)

= –$39,500 + $12,500(3.4331) = –$39,500 + $42,914
= $3,414. (Accept)

Financial calculator: Input the appropriate cash flows into the cash flow register, input
I = 14, and then solve for NPV = $3,414.

Financial calculator: Input the appropriate cash flows into the cash flow register and then
solve for IRR = 17.5%.
MIRR: PV Costs = $39,500.

FV Inflows:

PV FV
0 14% 1 2 3 4 5
| | | | | |
12,500 12,500 12,500 12,500 12,500
14,250
16,245
18,519
21,112
39,500 MIRR = 15.9% (Accept) 82,626

Financial calculator: Obtain the FVA by inputting N = 5, I = 14, PV = 0, PMT = 12500,

and then solve for FV = $82,626. The MIRR can be obtained by inputting N = 5,
PV = –39500, PMT = 0, FV = 82626, and then solving for I = 15.9%.

Pulley:

NPV =–-$94,800 + $31,000(3.4331) = –$94,800 + $106,426

= $11,626. (Accept)

Financial calculator: Input the appropriate cash flows into the cash flow register, input
I = 14, and then solve for NPV = $11,626.

Financial calculator: Input the appropriate cash flows into the cash flow register and then
solve for IRR = 19%.

MIRR: PV Costs = $94,800.

 FV Inflows:

PV FV
0 1 2 3 4 5
| | | | | |
31,000 31,000 31,000 31,000 31,000
14%
35,340
40,288
45,928
52,358
94,800 MIRR = 16.67% (Accept) 204,914

Financial calculator: Obtain the FVA by inputting N = 5, I = 14, PV = 0, PMT = 31000,

and then solve for FV = $204,913. The MIRR can be obtained by inputting N = 5,
PV = –94800, PMT = 0, FV = 204913, and then solving for I = 16.67%.

10-9 Electric-powered:

NPVE = -$22,000 + $6,290 [(1/i) – (1/(i*(1 + i)n)]

= -$22,000 + $6,290 [(1/0.12) – (1/(0.12*(1 + 0.12)6)]
= -$22,000 + $6,290(4.1114)
= -$22,000 + $25,861
= $3,861.

Financial calculator: Input the appropriate cash flows into the cash flow register, input
I = 12, and then solve for NPV = $3,861.

Financial calculator: Input the appropriate cash flows into the cash flow register and then
solve for IRR = 18%.

Gas-powered:

NPVG = -$17,500 + $5,000 [(1/i) – (1/(i*(1 + i)n)]

= -$17,500 + $5,000 [(1/0.12) – (1/(0.12*(1 + 0.12)6)]
= -$17,500 + $5,000(4.1114)
= -$17,500 + $20,557
= $3,057.

Financial calculator: Input the appropriate cash flows into the cash flow register, input
I = 12, and then solve for NPV = $3,057.

Financial calculator: Input the appropriate cash flows into the cash flow register and then
solve for IRR = 17.97% ≈ 18%.
 The firm should purchase the electric-powered forklift because it has a higher NPV
than the gas-powered forklift. The company gets a high rate of return (18% > r = 12%) on
a larger investment.
10-10 Financial calculator solution, NPV:

Project A

Inputs 5 10 7000 0

N I PV PMT FV

Output = –26,535.51

NPVA = $26,535.51 – $22,000 = $4,535.51.

Project B

Inputs 5 10 20000 0

N I PV PMT FV

Output = –75,815.74

NPVB = $75,815.74 – $70,000 = $5,815.74.

Financial calculator solution, IRR:

Project A: CF0 = –22000, CF1 = 7000, Nj = 5, IRRA = ? IRRA = 17.78%.
Project B: CF0 = –70000, CF1 = 20000, Nj = 5, IRRB = ? IRRB = 13.20%.

Financial calculator solution, MIRR:

Project A

Inputs 5 10 0 7000

N I PV PMT FV

Output = –42,735.70

PV costsA = $22,000.
FV inflowsA = $42,735.70.

Inputs 5 -22000 0 42,735.70

N I PV PMT FV

Output = 14.20

MIRRA = 14.20%.
Project B

Inputs 5 10 0 20000

N I PV PMT FV

Output = 122,102

PV costsB = $70,000.
FV inflowsB = $122,102.

Inputs 5 –70000 0 122,102

N I PV PMT FV

Output = 11.77

MIRRb = 11.77%.

$26,535.51 $75,815.74
PIA = = 1.206. PIB = = 1.083.
$22,000 $70,000

Thus, NPVB > NPVA; IRRA > IRRB; MIRRA > MIRRB; and PIA > PIB. The scale
difference between Projects A and B result in the IRR, MIRR, and PI favouring A over
B. However, NPV favours Project B, and therefore B should be chosen.
10-11 Because both projects are the same size you can just calculate each project’s MIRR and
choose the project with the higher MIRR. (Remember, MIRR gives conflicting results
from NPV when there are scale differences between the projects.)

Project J: 0 1 2 3 4
12%
| | | | |
–5,000 1,000 1,500 2,000 4,000.00
2,240.00
1,881.60
1,404.93
9,526.53
5,000 17.49% = MIRRJ

$5,000 = $9,529/(1 + MIRRJ)4.

Project K: 0 1 2 3 4
12%
| | | | |
–5,000 4,500 1,500 1,000 500.00
1,120.00
1,881.60
6,322.18
9,823.78
5,000 18.39% = MIRRK

$5,000 = $9,823.78/(1 + MIRRK)4.

Thus, since MIRRK > MIRRJ, Project K should be chosen.

Alternative step: You could calculate NPVs, see that Project K has the higher NPV, and
just calculate MIRRK.

NPVJ = $1,054.28 and NPVK = $1,243.19.

10-12 a. Purchase price $ 900,000

Installation 165,000
Initial outlay $1,065,000

CF0 = -1065000; CF1-5 = 350000; I = 14; NPV = ?

NPV = $136,578; IRR = 19.22%.

b. Ignoring environmental concerns, the project should be undertaken because its NPV
is positive and its IRR is greater than the firm’s cost of capital.
 c. Environmental effects could be added by estimating penalties or any other cash
outflows that might be imposed on the firm to help return the land to its previous state
(if possible). These outflows could be so large as to cause the project to have a
negative NPV—in which case the project should not be undertaken.

10-13 a.

r NPVA NPVB
0.0% $1,288 $820
10.0 $479 $372
12.0 $366 $308
14.8 $228 $229
18.0 $94 $150
20.7 $0 $93
25.8 −$149 $0
30.0 −$245 −$62
b. At r = 10%, Project A has the greater NPV, specifically $478.83 as compared to
Project B’s NPV of $372.37. Thus, Project A would be selected. At r = 17%, Project
B has an NPV of $173.70, which is higher than Project A’s NPV of $133.76. Thus,
choose Project B if r = 17%.

c. Here is the MIRR for Project A when r = 10%:

PV costs = $400 + $528/(1.10)1 + $219/(1.10)2

+ $150/(1.10)3 + $325/(1.10)7 = $1,340.47

TV inflows = $1,100(1.10)3 + $820(1.10)2 + $990(1.10)1 = $3,545.30.

Now, MIRR is that discount rate which forces the PV of $3,545.30 in 7 years to equal
$1,340.47:

$1,340.47 = $3,545.30/(1 + MIRR)7

MIRRA = 14.91%.

Here is the MIRR for Project B when r = 10%:

PV costs = 650.
TV of inflows: Financial calculator settings are N = 7, I/YR = 10, PV = 0, PMT =
210, and solve for FV = –1992.3059.

Similarly, $650 = $1,992.31/(1 + MIRR)7

MIRRB = 17.35%.

At r = 17%,
MIRRA = 18.76%.
MIRRB = 21.03%.
d. To find the crossover rate, construct a Project ∆, which is the difference in the two
projects’ cash flows:
Year Project ∆ = CFA – CFB
0 $250
1 −738
2 −429
3 −360
4 890
5 610
6 780
7 −535

IRR∆ = Crossover rate = 14.76%.

Projects A and B are mutually exclusive, thus, only one of the projects can be chosen.
As long as the cost of capital is greater than the crossover rate, both the NPV and IRR
methods will lead to the same project selection. However, if the cost of capital is less
than the crossover rate the two methods lead to different project selections—a conflict
exists. When a conflict exists the NPV method must be used.

Because of the sign changes and the size of the cash flows, Project ∆ has multiple
IRRs. Thus, the IRR function for some calculators will not work (it will work,
however, on a BAII Plus). The HP can be “tricked” into giving the roots by selecting
an initial guess near one of the roots. After you have keyed Project Delta’s cash flows
into the CFj register of an HP-10B, you will see an “Error-Soln” message. Now enter
10; STO; IRR/YR and the 14.76% IRR is found. Then enter 100; STO; IRR/YR to
obtain IRR = 246.02%. Similarly, Excel can also be used.
10-14 a. Incremental Cash
Year Plan B Plan A Flow (B – A)
0 ($10,000,000) ($10,000,000) $ 0
1 1,750,000 12,000,000 (10,250,000)
2–20 1,750,000 0 1,750,000

If the firm goes with Plan B, it will forgo $10,250,000 in Year 1, but will receive
$1,750,000 per year in Years 2–20.

b. If the firm could invest the incremental $10,250,000 at a return of 16.07%, it would
receive cash flows of $1,750,000. If we set up an amortization schedule, we would
find that payments of $1,750,000 per year for 19 years would amortize a loan of
$10,250,000 at 16.0665%.

Financial calculator solution:

Inputs 19 –10250000 1750000 0

N I PV PMT FV

Output = 16.0665

c. Yes, assuming (1) equal risk among projects, and (2) that the cost of capital is a
constant and does not vary with the amount of capital raised.

d. See graph. If the cost of capital is less than 16.07%, then Plan B should be accepted;
if r > 16.07%, then Plan A is preferred.

NPV (Millions of Dollars)

25

B
20

15

10 Crossover Rate = 16.07%

A
IRRB = 16.7%
5
IRRA = 20%

Cost of
Capital (%)
5 10 15 20 25
10-15 a. Financial calculator solution:

Plan A

Inputs 20 10 8000000 0

N I PV PMT FV

Output = –68,108,510

NPVA = $68,108,510 – $50,000,000 = $18,108,510.

Plan B

Inputs 20 10 3400000 0

N I PV PMT FV

Output = –28,946,117

NPVB = $28,946,117 – $15,000,000 = $13,946,117.

Plan A

Inputs 20 –50000000 8000000 0

N I PV PMT FV

Output = 15.03

IRRA = 15.03%.

Plan B

Inputs 20 –15000000 3400000 0

N I PV PMT FV

Output = 22.26

IRRB = 22.26%.
b. If the company takes Plan A rather than B, its cash flows will be (in millions of
dollars):
Cash Flows Cash Flows Project ∆
Year from A from B Cash Flows
0 $(50) $(15.0) $(35.0)
1 8 3.4 4.6
2 8 3.4 4.6
. . . .
. . . .
. . . .
20 8 3.4 4.6

So, Project ∆ has a “cost” of $35,000,000 and “inflows” of $4,600,000 per year for 20
years.

Inputs 20 10 4600000 0

N I PV PMT FV

Output = –39,162,393

NPV = $39,162,393 – $35,000,000 = $4,162,393.

Inputs 20 –35000000 4600000 0

N I PV PMT FV

Output = 11.71

IRR = 11.71%.

Since IRR∆ > r, we should accept ∆. This means accept the larger project (Project A).
In addition, when dealing with mutually exclusive projects, we use the NPV method
for choosing the best project.
 c.
NPV (Millions of Dollars)

125

A
100 Crossover Rate = 11.7%

75 B

50 IRRA = 15.03%
IRRB = 22.26%

25

5 10 15 20 25 30

Cost of Capital (%)

-25

IRR = 11.7%
-50

d. The NPV method implicitly assumes that the opportunity exists to reinvest the cash
flows generated by a project at the cost of capital, while use of the IRR method
implies the opportunity to reinvest at the IRR. If the firm’s cost of capital is constant
at 10 percent, all projects with an NPV > 0 will be accepted by the firm. As cash
flows come in from these projects, the firm will either pay them out to investors, or
use them as a substitute for outside capital, which costs 10 percent. Thus, since these
cash flows are expected to save the firm 10 percent, this is their opportunity cost
reinvestment rate.

The IRR method assumes reinvestment at the internal rate of return itself, which is an
incorrect assumption, given a constant expected future cost of capital, and ready
access to capital markets.

10-16 The EAA of ship A is found by first finding the PV: N = 7, I/YR = 12, PMT = 17,
FV= 0; solve for PV = −77.58. The NPV is $77.58 − $60 = $17.58 million. We
convert this to an equivalent annual annuity by inputting: N = 7, I/YR = 12,
PV = −17.58, FV = 0, and solve for PMT = EAA = $3.85 million.

For ship B, the NPV = 24.42. We convert this to an equivalent annual annuity by
inputting: N = 14, I/YR = 12, PV = −24.42, FV = 0, and solve for PMT = EAA =
$3.68 million.

Ship A has the higher equivalent annual annuity, and should be accepted.
10-17 The EAA of machine A is found by first finding the PV: N = 5, I/YR = 12,
PMT = .9, FV = 0; solve for PV = −3.244. The NPV is $3.244 − $2.5 = $0.744
million. We convert this to an equivalent annual annuity by inputting: N = 5,
I/YR = 12, PV = −0.744, FV = 0, and solve for PMT = EAA = 0.206 ≈ $206,000.

For machine B, the NPV = $0.863 million. We convert this to an equivalent annual
annuity by inputting: N = 9, I/YR = 12, PV = −0.863, FV = 0, and solve for PMT =
EAA = 0.162 ≈ $162,000. Accept machine A.

10-18 The EAA of machine 190-3 is found by converting its NPV to an equivalent annual
annuity by inputting: N = 3, I/YR = 14, PV = −11,981.99, FV = 0, and solve for
PMT = EAA = 5,161.02.

The EAA of machine 360-6 is found by converting its NPV to an equivalent annual
annuity by inputting: N = 6, I/YR = 14, PV = −22,256.02, FV = 0, and solve for
PMT = EAA = 5,723.30.

Both new machines have positive NPVs, hence the old machine should be replaced.
Choose Model 360-6.
10-19 a. The project’s expected cash flows are as follows (in millions of dollars):
Time Net Cash Flow
0 $( 4.4)
1 27.7
2 (25.0)

We can construct the following NPV profile:

NPV (Millions of Dollars)
Maximum
3 NPV at 80.5%

Discount
Rate (%)
10 20 80.5 420

-1
IRR1 = 9.2% IRR2 = 420%

-2

-3
NPV approaches -$4.4 as
the cost of capital
-4 approaches 
-4.4

Discount Rate NPV

0% ($1,700,000)
9 (29,156)
10 120,661
50 2,955,556
100 3,200,000
200 2,055,556
300 962,500
400 140,000
410 70,204
420 2,367
430 (63,581)

The table above was constructed using a financial calculator with the following
inputs: CF0 = –4400000, CF1 = 27700000, CF2 = -25000000, and I = discount rate to
solve for the NPV.
b. If r = 8%, reject the project since NPV < 0. But if r = 14%, accept the project because
NPV > 0.

c. Other possible projects with multiple rates of return could be nuclear power plants
where disposal of radioactive wastes is required at the end of the project’s life, or
leveraged leases where the borrowed funds are repaid at the end of the lease life.

d. Here is the MIRR for the project when r = 8%:

PV costs = $4,400,000 + $25,000,000/(1.08)2 = $25,833,470.51.

TV inflows = $27,700,000(1.08)1 = $29,916,000.00.
Now, MIRR is that discount rate which forces the PV of the TV of $29,916,000 over
2 years to equal $25,833,470.51:

$25,833,470.51 = $29,916,000(PVIFr,2).

Inputs 2 –25833470.51 0 29916000

N I PV PMT FV

Output = 7.61
MIRR = 7.61%.
At r = 14%,
Inputs 2 –23636688.21 0 31578000

N I PV PMT FV

Output = 15.58
MIRR = 15.58%.
PV costs = $4,400,000 + $25,000,000/(1.14)2 = $23,636,688.21.
TV inflows = $27,700,000(1.14)1 = $31,578,000.
Now, MIRR is that discount rate which forces the PV of the TV of $31,578,000 over
2 years to equal $23,636,688.21:

$23,636,688.21 = $31,578,000(PVIFr,2).

Yes. The MIRR method leads to the same conclusion as the NPV method. Reject the
project if r = 8%, which is greater than the corresponding MIRR of 7.61%, and accept
the project if r = 14%, which is less than the corresponding MIRR of 15.58%.
10-20 Step 1: Determine the PMT:
0 12% 1 10
| | ••• |
–1,000 PMT PMT

The IRR is the discount rate at which the NPV of a project equals zero. Since we
know the project’s initial investment, its IRR, the length of time that the cash
flows occur, and that each cash flow is the same, then we can determine the
project’s cash flows by setting it up as a 10-year annuity. With a financial
calculator, input N = 10, I/YR = 12, PV = –1000, and FV = 0 to obtain PMT =
$176.98.

Step 2: Since we’ve been given the WACC, once we have the project’s cash flows we can
now determine the project’s MIRR.

Calculate the project’s MIRR:

0 10% 1 2 9 10
| | | ••• | |
–1,000 176.98 176.98 176.98 176.98
 1.10
194.68
.
.
.
 (1.10)8
 (1.10)9
379.37
417.31
1,000 10.93% = MIRR TV = 2,820.61

FV of inflows: With a financial calculator, input N = 10, I/YR = 10, PV = 0, and

PMT = –176.98 to obtain FV = $2,820.61. Then input N = 10, PV = –1000, PMT
= 0, and FV = 2820.61 to obtain I/YR = MIRR = 10.93%.

10-21 The PV of costs for the conveyor system is ($496,401), while the PV of costs for the
forklift system is ($461,171). Thus, the forklift system is expected to be ($496,401) –
($461,171) = $35,230 less costly than the conveyor system, and hence the forklift trucks
should be used.

Financial calculator solution:

Input: CF0 = –250000, CF1 = –65000, Nj = 5, I = 10, NPVC = ?

NPVC = –496401.

Input: CF0 = –120000, CF1 = –90000, Nj= 5, I = 10, NPVF = ? NPVF = –461171.
10-22 a. Payback A (cash flows in thousands):

Annual
Period Cash Flows Cumulative
0 $(25,000) $(25,000)
1 5,000 (20,000)
2 10,000 (10,000)
3 15,000 5,000
4 20,000 25,000

PaybackA = 2 + $10,000/$15,000 = 2.67 years.

Payback B (cash flows in thousands):

Annual
Period Cash Flows Cumulative
0 $(25,000) $25,000)
1 20,000 (5,000)
2 10,000 5,000
3 8,000 13,000
4 6,000 19,000

PaybackB = 1 + $5,000/$10,000 = 1.50 years.

b. Discounted payback A (cash flows in thousands):

Annual Discounted @10%

Period Cash Flows Cash Flows Cumulative
0 $(25,000) $(25,000.00) $ (25,000.00)
1 5,000 4,545.45 (20,454.55)
2 10,000 8,264.46 (12,190.09)
3 15,000 11,269.72 (920.37)
4 20,000 13,660.27 12,739.90

Discounted PaybackA = 3 + $920.37/$13,660.27 = 3.07 years.

Discounted payback B (cash flows in thousands):

Annual Discounted @10%

Period Cash Flows Cash Flows Cumulative
0 $(25,000) $(25,000.00) $ (25,000.00)
1 20,000 18,181.82 (6,818.18)
2 10,000 8,264.46 1,446.28
3 8,000 6,010.52 7,456.80
4 6,000 4,098.08 11,554.88

Discounted PaybackB = 1 + $6,818.18/$8,264.46 = 1.83 years.

c. NPVA = $12,739,908; IRRA = 27.27%.

NPVB = $11,554,880; IRRB = 36.15%.

Both projects have positive NPVs, so both projects should be undertaken.

d. At a discount rate of 5%, NPVA = $18,243,813.

At a discount rate of 5%, NPVB = $14,964,829.

At a discount rate of 5%, Project A has the higher NPV; consequently, it should be
accepted.

e. At a discount rate of 15%, NPVA = $8,207,071.

At a discount rate of 15%, NPVB = $8,643,390.

At a discount rate of 15%, Project B has the higher NPV; consequently, it should be
accepted.
f. Project ∆ =
Year CFA – CFB
0 $ 0
1 (15)
2 0
3 7
4 14

IRR∆ = Crossover rate = 13.5254% ≈ 13.53%.

g. Use 3 steps to calculate MIRRA @ r = 10%:

Step 1: Calculate the NPV of the uneven cash flow stream, so its FV can then be
calculated. With a financial calculator, enter the cash flow stream into the cash
flow registers, then enter I = 10, and solve for NPV = $37,739,908.

Step 2: Calculate the FV of the cash flow stream as follows:

Enter N = 4, I = 10, PV = –37739908, and PMT = 0 to solve for
FV = $55,255,000.

Step 3: Calculate MIRRA as follows:

Enter N = 4, PV = –25000000, PMT = 0, and FV = 55255000 to solve for
I = 21.93%.

Use 3 steps to calculate MIRRB @ r = 10%:

Step 1: Calculate the NPV of the uneven cash flow stream, so its FV can then be
calculated. With a financial calculator, enter the cash flow stream into the cash
flow registers, then enter I = 10, and solve for NPV = $36,554,880.

Step 2: Calculate the FV of the cash flow stream as follows:

Enter N = 4, I = 10, PV = –36554880, and PMT = 0 to solve for
FV = $53,520,000.

Step 3: Calculate MIRRB as follows:

Enter N = 4, PV = –25000000, PMT = 0, and FV = 53520000 to solve for
I = 20.96%.

According to the MIRR approach, if the 2 projects were mutually exclusive, Project
A would be chosen because it has the higher MIRR. This is consistent with the NPV
approach.
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