FIN302- Chpt 10 HW Solutions and NOTES
FIN302- Chpt 10 HW Solutions and NOTES FIN302
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Date Created: 11/09/15
Giulia Dias Roneoletta FN302 November 4 2015 Chapter 10 Homework Solutions Notes 2 Net Present Value L01 Suppose a project has conventional cash ows and a positive NPV What do you know about its payback Its discounted payback Its pro tability index Its IRR39 Explain 2 Net Present Value L01 If a project has a positive NPV it will have a positive NPV at any discount rate including zero Therefore the payback period must be less than the project s life The profitability index must be greater than 1 since NPV is positive If the discount rate increases NPV decreases IFlFl must be greater than the required return since NPV is positive I Calculating Payback L02 What is the payback period for the following set of cash ows Year Cash Flow 0 5500 1 1300 2 1500 3 1900 4 1400 2 Calculating Payback L02 An investment project provides cash in ows of 585 per year for eight years What is the project payback period if the initial cost is SL700 What if the initial cost is 3300 What if it is 34900 1 Calculating PaybackL02 To calculate payback period start with adding up the payments up to the closest amount to the initial investment 1 1300 2 2800 3 4700 3 470055001400 357 years 2 Calculating PaybackL02 1 585 291 years 1700 2 585 547 years 3300 3 585 838 years 4900 4 585 5 585 7 Calculating RR L05 A rm evaluates all of its projects by applying the IRR rule If the required return is l4 percent should the linn accept the following project Year Cash Flow 0 528000 1 12000 2 15000 3 1 t 000 8 Calculating NPV L01 For the cash ows in the previous problem suppose the rm uses the NPV decision rule At a required return of l 1 percent should the firm accept this project What if the required return is 25 percent 7 Calculating IRRL05 This is calculated by plugging in the cash flows in the the calculator then computing IRR by using the 14 required return Yes we would accept the project because the IRR is higher than the required return 8 Calculating NPVLO1 Again plug in cashflows then compute NPV 11 30282525 25 316800 gt reject the project at 25 because the NPV is negative 12 NPV versus RR L01 5 Garage lnc has identified the following two mutually exclusive projects Your Cash Flow W Cash Flow 8 0 29100 quot529000 1 144X 4300 2 12300 9800 3 9200 15200 4 5100 16800 8 What is the IRR for each of these projects Using the IRR decision rule which project should the company accept Is this decision necessarily correct b If the required return is l l percent what is the NPV for each of these projects Which project will the company choose if it applies the NPV decision rule c Over what range of discount rates would the company choose project A Project B At what discount rate would the company he inditTerent between these two projects Explain 12 NPV versus IRRLO15 a Project A RR 1855 Project B IRR 1742 b at 11 required return Project A NPV 404242 Project B NPV 500856 gt there s a ranking problem in IRR criterion for mutually exclusive projects which is why we must test NPV as well gt we would accept project B since NPV is higher at 11 required return c 0 0 Crossover rate 1483 1 10100 therefore for above 1483 2 2500 pick project A and for below 3 6000 prick project B 4 11700 to calculate the cross over rate find the difference in cashflows and compute IRR I4 15 16 Problems with lid L05 Light Sweet Petroleum Inc is trying to evaluate a generation project with the following cmh ows Year Cub Flow 0 39000000 1 63000000 2 12000000 a If the company requires a l2 percent return on its investments should it accept this project Why b Compute the RR for this project How many lRRs are there Using the RR decision rule should the company accept the project What s going on here Calculating Pro tability Index L07 What is the pro tability index for the following set of cash ows if the relevant discount rate is 10 percent What if the discount rate is l5 percent If it is 22 percent Your Caah Flow 0 18000 1 10300 2 9200 3 5700 Problems with Pro tability Index L01 7 The Angry Bird Corporation is trying to choose between the following two mutually exclusive design projecm YOU Coah Flow 0 Coah Flow II 0 364000 181 1 31000 9700 2 31000 9700 3 31000 9700 a If the required return is 10 percent and the company applies the po tability index decision rule which project should the rm accept b If the company applies the N W decision rule which project should it take c Explain why your answers in a and b are different 14 Problems with IRRL05 a after calculating NPV on calc NPV7683673469 it s not zero or negative number so we will accept the project b IRR DONT KNOW HOW TO CALCULATE MULTIPLE IRRS 15 Calculating Profitability Index calculate PI in your calculator by only putting positive cash flows in cash flows and calculating NPV at a specified and dividing it by the negative cash flows initial investment PI at 10 1180 PI at 15 1092 PI at 22 0987 gt accept projects that have a higher Pl than 1 16 Problems With Profitability Index L01 a Project 1 Pi 1205 Project II Pi 1340 gt based on Pl we would accept project If since the PI is higher b Project 1 NPV 7709242 Project II NPV 241224643 gt the NPV decision rule implies that we should pick project I intend because the NPV is higher c Project is twice as big as project II but the Pl puts them into scale which is hard to tell which should be more acceptable if they re different investment sizes 26 Problems with IRR L05 A project has the following cash flows Your Cash Flow 0 4200 1 21003 2 32003 What is the IRR for this project If the required return is l2 percent should the firm accept the project What is the NPV of this project What is the NPV of the project if the required retum is percent 24 percent What is going on here Sketch the NPV profile to help you with your answer 26 Problems with IRR This problem has no real IRR NOTES To calculate payback period you must first find the time when the project has covered its initial investment IRR is the interest rate that makes NPV equal to zero To calculate IRR which is the interest rate that makes NPV zero and measures the attractiveness of a project the higher the more desirable on a financial calculator first input all cash flows on CF then compute IRR To calculate crossover rates simply subtract cash flows The one being subtracted is above the ratio the other is below If theres another negative cash flow there s another IRR The profitability index is the ratio between cash in and our flows To solve for PV of cash inflows PV CF11required return CF21rrquot2 To calculate PV of positive cashflow just don39t include any negative numbers in calculator and compute for NPV and divide by negative cashflow
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