FIN5320-6 - FIN5320 PDF

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FINC 5000 - HW Assignment for Week 6 - ERIK BUSCHARDT (2/13/19) For Week 6, please turn in the answers to the following questions: 1. Scott Enterprises is considering a project that has the following cash flow and cost of capital (r) data. What is the project's NPV? (Note that if a project's expected NPV is negative, it should be rejected.) - Given Answer: $85.86 r: Year Cash flows

11.00% 0 −$1,000

1 $350

2 $350

3 $350

4 $350

Per page 417, NPV = CF0 + CF1/(1+r)^1 + CF2/(1+r)^2 + CF3/(1+r)^3 + CF4/(1+r)^4 = (-1,000) + (350/(1.11)^1) + (350/(1.11)^2) + (350/(1.11)^3) + (350/(1.11)^4) = 85.8559

2. Reed Enterprises is considering a project that has the following cash flow and cost of capital (r) data. What is the project's NPV? (Note that a project's expected NPV can be negative, in which case it will be rejected.) - Given Answer: $92.37 r: Year Cash flows

10.00% 0 −$1,050

1 $450

2 $460

3 $470

Per page 417, NPV = CF0 + CF1/(1+r)^1 + CF2/(1+r)^2 + CF3/(1+r)^3 = (-1,050) + (450/(1.10)^1) + (460/(1.10)^2) + (470/(1.10)^3) = 92.3742

3. Hart Corp. is considering a project that has the following cash flow data. What is the project's IRR? (Note that a project's IRR can be less than the cost of capital or negative, in both cases it will be rejected.) - Given Answer: 13.21% Year Cash flows

0 −$1,000

1 $425

2 $425

3 $425

Per page 420-421, NPV = 0 = CF0 + CF1/(1+IRR)^1 + CF2/(1+IRR)^2 + CF3/(1+IRR)^3 0 = (-1,000) + 425/(1+IRR)^1 + 425/(1+IRR)^2 + 425/(1+IRR)^3 Using Excel, =IRR(-1000,425,425,425) yields 0.132054. 4. Pet World is considering a project that has the following cash flow data. What is the project's IRR? (Note that a project's IRR can be less than the cost of capital, and even negative, in which case it will be rejected.) - Given Answer: 2.57% Year Cash flows

0 −$9,500

1 $2,000

2 $2,025

3 $2,050

4 $2,075

5 $2,100

Again using Excel, =IRR( {-9500,2000,2025,2050,2075,2100} ) yields 2.5660%. 5. Computer Consultants Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is the project's MIRR? (Note that a project's MIRR can be less than the cost of capital, and even negative, in which case it will be rejected.) - Given Answer: 14.20% r = Year Cash flows

10.00% 0 −$1,000

1 $450

2 $450

3 $450

Using Excel with r = 0.10, CF[Y=0] = -1K, and CF[1-3] = 450 each, we have: =MIRR( {-1000,450,450,450} ,0.1) = 14.2037%.

6.

McGlothin Inc. is considering a project that has the following cash flow data. What is the project's payback? - Given Answer: 2.30

Year Cash flows

0 −$1,150

1 $500

2 $500

3 $500

Per Ch10 Tool Kit and using the column for Project S, this payback will be 2.30 years.

7. Craig's Car Wash Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is the project's discounted payback? - Given Answer: 2.09 r = Year Cash flows

10.00% 0 −$900

1 $500

2 $500

3 $500

Per the same toolkit above and using the column for Project L, this discounted payback will be 2.09 yrs.

8. Markman & Sons is considering Projects S and L. These projects are mutually exclusive, equally risky, and not repeatable and their cash flows are shown below. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? (Note that under certain conditions, choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, i.e., no conflict will exist.) - Given Answer: $7.82 r: Year CFS CFL

10.00% 0 −$1,025 −$1,025

1 $650 $100

2 $450 $300

3 $250 $500

4 $50 $700

Again using Figure 10-1 (Ch10 Toolkit), we have: NPV[L] = $167.61, subtract NPV[S] = $159.79 $7.82.

9. What are two possible causes of conflicts between the IRR and NPV for mutually exclusive projects? As per section 10-4-c (pages 423-425), two possible conflicts described are: (1) How to select the project with a higher NPV, and (2) Differences with timing and scale.

10. Suppose a firm relies exclusively on the payback or discounted payback period methods when making capital budgeting decisions. What benefit does the approach of using payback methods provide and what pitfalls does this approach have? From section 10-7, we see that calculating payback for a project does not take into consideration TVM, which is resolved by the WACC to produce a discounted payback. Secondly, CF beyond the last year of the project are not considered, a “serious flaw”, as per page 431, paragraph 3, (line 24). Finally, the payback calculation avoids looking at the larger picture, when in fact stakeholders of a project should always do so....