Chapter 10 Capital Investment Decision Analysis-I

 111) If the NPV (Net Present Value) of a project with multiple sign reversals is positive, then the project's required rate of return ________ its calculated IRR (Internal Rate of Return).

A) must be less than

B) must be greater than

C) could be greater or less than

D) cannot be determined without actual cash flows

112) Kingston Corp. is considering a new machine that requires an initial investment of $480,000 installed, and has a useful life of 8 years. The expected annual after-tax cash flows for the machine are $89,000 for each of the 8 years and nothing thereafter.

a. Calculate the net present value of the machine if the required rate of return is 11 percent.

b. Calculate the IRR of this project.

c. Should Kingston accept the project (assume that it is independent and not subject to any capital rationing constraint)? Explain your answer.

113) D&B Contracting plans to purchase a new backhoe. The one under consideration costs $233,000, and has a useful life of 8 years. After-tax cash flows are expected to be $31,384 in each of the 8 years and nothing thereafter. Calculate the internal rate of return for the grader.

114) Consider two mutually exclusive projects X and Y with identical initial outlays of $600,000 and useful lives of 5 years. Project X is expected to produce an after-tax cash flow of $180,000 each year. Project Y is expected to generate a single after-tax net cash flow of $1,015,000 in year 5. The discount rate is 14 percent.

a. Calculate the net present value for each project.

b. Calculate the IRR for each project.

c. What decision should you make regarding these projects?

115) A project that requires an initial investment of $340,000 is expected to have an after-tax cash flow of $70,000 per year for the first two years, $90,000 per year for the next two years, and $150,000 for the fifth year? Assume the required return for this project is 10%.

a. What is the NPV of the project%?

b. What is the IRR of the project?

c. What is the MIRR of the project?

d. What is the PI of the project?

e. What decision would you make regarding this project if the required rate of return is 10%?

f. What is the equivalent annual annuity using a 10% required rate of return?

116) The Bolster Company is considering two mutually exclusive projects:

Year	Initial Outlay	NPV
0	-$100,000	-$100,000
1	31,250	0
2	31,250	0
3	31,250	0
4	31,250	0
5	31,250	200,000

The required rate of return on these projects is 12 percent.

a. What is each project's payback period?

b. What is each project's discounted payback period?

c. What is each project's net present value?

d. What is each project's internal rate of return?

e. Fully explain the results of your analysis. Which project do you prefer, and why?

Learning Objective 3

1) The payback period may be more appropriate to use for companies experiencing capital rationing.

2) The profitability index can be helpful when a financial manager encounters a situation where capital rationing is required.

3) Positive NPV projects may be rejected when capital must be rationed.

4) Capital rationing generally leads to higher stock prices as management is doing the best job it can in selecting only the best capital budgeting projects.