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CHAPTER 13 - WEIGHING NET PRESENT VALUE AND OTHER CAPITAL BUDGETING CRITERIA

Questions

LG1 1. Is the set of cash flows depicted below normal or non-normal? Explain.

|Time |0 |1 |2 |3 |4 |5 |

|Cash Flow |-$100 |-$50 |$80 |$0 |$100 |$100 |

They’re normal: there is only one change in cash flows from negative to positive.

LG1 2. Derive an accept/reject rule for IRR similar to 13-8 that would make the correct decision on cash flows that are non-normal, but which always have one large positive cash flow at time zero followed by a series of negative cash flows:

LG7 8. Suppose a company wanted to double their firm’s value with the next round of capital budgeting project decisions. To what would they set the PI benchmark to make this goal?

They would set it equal to 1.

LG5 9. Suppose a company faced different borrowing and lending rates: How would this range change the way that you would compute the MIRR statistic?

We would want to use the borrowing rate to move the negative cash flows to time 0, and the lending rate to move the positive cash flows to the end of the project.

Problems

Basic Problems

LG2 13-1 Compute the NPV for Project M and accept or reject the project with the cash flows shown below if the appropriate cost of capital is 8 percent.

Project M

| Time |0 |1 |2 |3 |4 |5 |

|Cash Flow |-$1,000 |$350 |$480 |$520 |$300 |$100 |

Using equation 13-2:

[pic]

The project should be accepted.

LG2 13-2 Compute the NPV statistic for Project Y and tell whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 12 percent.

Project Y

| Time |0 |1 |2 |3 |4 |

|Cash Flow |-$11,000 |$3,350 |$4,180 |$1,520 |$2,000 |

Using equation 13-2:

[pic]

The project should be rejected.

LG2 13-3 Compute the NPV statistic for Project U and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 10 percent.

Project U

| Time |0 |1 |2 |3 |4 |5 |

|Cash Flow |-$1,000 |$350 |$1,480 |-$520 |$300 |-$100 |

Using equation 13-2:

[pic]

The project should be accepted.

LG3 13-4 Compute the Payback statistic for Project A and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 8 percent and the maximum allowable payback is 4 years.

Project A

| Time |0 |1 |2 |3 |4 |5 |

|Cash Flow |-$1,000 |$350 |$480 |$520 |$300 |$100 |

Solving equation 13-3 for N, cumulative cash flow will switch from negative and positive between years 2 and 3:

|Year |0 |1 |2 |3 |4 |5 |

|Cash Flow |-$1,000 |$350 |$480 |$520 |$300 |$100 |

|Cumulative Cash Flow |-$1,000 |-$650 |-$170 |$350 | ...

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