Economics Chapter 11 3 Note that a project’s projected MIRR can be

Chapter 11: The Basics of Capital Budgeting

0

91.

Maxwell Feed & Seed is considering a project that has the following cash flow data. What is the project’s

IRR?

Note that a project’s projected IRR can be less than the WACC (and even negative), in which case it

will be

rejected.

Year

0

1

2

3

4

5

Cash flows

a. 2.08%

−$9,500

$2,000

$2,025

$2,050

$2,075

$2,100

b. 2.31%

c. 2.57%

d. 2.82%

e. 3.10%

92.

Last month, Lloyd’s Systems analyzed the project whose cash flows are shown below. However, before the

decision to accept or reject the project, the Federal Reserve took actions that changed interest rates and

therefore

the firm’s WACC. The Fed’s action did not affect the forecasted cash flows. By how much did the

change in the

WACC affect the project’s forecasted NPV? Note that a project’s projected NPV can be

negative, in which case it

should be rejected.

Old WACC:

Year

10.00%

0

New WACC: 11.25%

1

2

3

Cash flows

−$1,00

$41

$410

a. −$18.89

b. −$19.88

c. −$20.93

d. −$22.03

e. −$23.13

WACC:

10.00%

93.

Lasik Vision Inc. recently analyzed the project whose cash flows are shown below. However, before Lasik

decided to accept or reject the project, the Federal Reserve took actions that changed interest rates and

therefore

the firm’s WACC. The Fed’s action did not affect the forecasted cash flows. By how much did the

change in the

WACC affect the project’s forecasted NPV? Note that a project’s projected NPV can be

negative, in which case it

should be rejected.

Old WACC:

Year

8.00%

0

New WACC: 11.25%

1

2

3

Cash flows

−$1,00

$41

$410

a. −$59.03

b. −$56.08

c. −$53.27

d. −$50.61

e. −$48.08

94.

Ehrmann Data Systems is considering a project that has the following cash flow and WACC data. What is the

project’s MIRR? Note that a project’s projected MIRR can be less than the WACC (and even negative), in

which

case it will be rejected.

WACC:

Year

10.00%

0

1

2

3

Cash flows

a. 9.32%

−$1,000

$450

b. 10.35%

c. 11.50%

d. 12.78%

e. 14.20%

WACC:

11.00%

0

Compounded values, FVs

95.

Ingram Electric Products is considering a project that has the following cash flow and WACC data. What is

the

project’s MIRR? Note that a project’s projected MIRR can be less than the WACC (and even negative), in

which

case it will be rejected.

WACC:

Year

11.00%

0

1

2

3

Cash flows

a. 8.86%

−$800

$350

b. 9.84%

c. 10.94%

d. 12.15%

e. 13.50%

96.

Malholtra Inc. is considering a project that has the following cash flow and WACC data. What is the project’s

MIRR? Note that a project’s projected MIRR can be less than the WACC (and even negative), in which case

it

will be rejected.

WACC:

Year

10.00%

0

1

2

3

4

Cash flows

a. 14.08%

−$850

$300

$320

$340

$360

b. 15.65%

c. 17.21%

d. 18.94%

e. 20.83%

Compounded values

97.

Hindelang Inc. is considering a project that has the following cash flow and WACC data. What is the

project’s

MIRR? Note that a project’s projected MIRR can be less than the WACC (and even negative), in

which case it

will be rejected.

WACC:

Year

12.25%

0

1

2

3

4

Cash flows

a. 13.42%

−$850

$300

$320

$340

$360

b. 14.91%

c. 16.56%

d. 18.22%

e. 20.04%

98.

Stern Associates is considering a project that has the following cash flow data. What is the project’s payback?

Year

0

1

2

3

4

5

Cash flows

a. 2.31 years

−$1,100

$300

$310

$320

$330

$340

b. 2.56 years

c. 2.85 years

d. 3.16 years

e. 3.52 years

Payback = 2.22

99.

Fernando Designs is considering a project that has the following cash flow and WACC data. What is the

project’s

discounted payback?

WACC:

Year

10.00%

0

1

2

3

Cash flows

a. 1.88 years

−$900

$500

b. 2.09 years

c. 2.29 years

d. 2.52 years

e. 2.78 years

100.

Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project’s

discounted payback?

WACC:

Year

10.00%

0

1

2

3

4

Cash flows

a. 1.61 years

−$950

$525

$485

$445

$405

b. 1.79 years

c. 1.99 years

d. 2.22 years

e. 2.44 years

101.

Tesar Chemicals is considering Projects S and L, whose cash flows are shown below. These projects are

mutually

exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection

criterion, while the

CFO advocates the NPV. If the decision is made by choosing the project with the higher

IRR rather than the one

with the higher NPV, how much, if any, value will be forgone, i.e., what’s the chosen

NPV versus the maximum

possible NPV? Note that (1) “true value” is measured by NPV, and (2) under some

conditions the choice of IRR

vs. NPV will have no effect on the value gained or lost.

WACC:

Year

7.50%

0

1

2

3

4

CFS

−$1,100

$550

$600

$100

CFL

−$2,700

$650

$725

$800

$1,400

a. $138.10

b. $149.21

c. $160.31

d. $171.42

e. $182.52

c

102.

A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually

exclusive,

equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors

the NPV method.

You were hired to advise the firm on the best procedure. If the wrong decision criterion is

used, how much

potential value would the firm lose?

WACC:

Year

6.00%

0

1

2

3

4

CFS

−$1,025

$380

CFL

−$2,150

$765

a. $188.68

b. $198.61

c. $209.07

d. $219.52

e. $230.49

103.

Sexton Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually

exclusive, equally risky, and not repeatable. 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 one with the higher IRR will also have the higher

NPV, so no value will

be lost if the IRR method is used.

WACC:

Year

10.25%

0

1

2

3

4

CFS

−$2,050

$750

$760

$770

$780

CFL

−$4,300

$1,500

$1,518

$1,536

$1,554

a. $134.79

b. $141.89

c. $149.36

d. $164.29

e. $205.36

2

4

CFS

$760

$780

104.

Moerdyk & Co. is considering Projects S and L, whose cash flows are shown below. These projects are

mutually

exclusive, equally risky, and not repeatable. 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 one with the higher IRR will also have the

higher NPV, i.e., no conflict

will exist.

WACC:

Year

10.00%

0

1

2

3

4

CFS

−$1,025

$650

$450

$250

$50

CFL

−$1,025

$100

$300

$500

$700

a. $5.47

b. $6.02

c. $6.62

d. $7.29

e. $7.82

CFS

105.

Kosovski Company is considering Projects S and L, whose cash flows are shown below. These projects are

mutually exclusive, equally risky, and are not repeatable. If the decision is made by choosing the project with

the

higher IRR, how much value will be forgone? Note that under some conditions choosing projects on the

basis of the

IRR will cause $0.00 value to be lost.

WACC: 7.75%

Year

0

1

2

3

4

CFS −$1,050 $675 $650

CFL −$1,050 $360 $360 $360 $360

a. $11.45

b. $12.72

c. $14.63

d. $16.82

e. $19.35

106.

Nast Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually

exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the higher

MIRR

rather than the one with the higher NPV, how much value will be forgone? Note that under some

conditions

choosing projects on the basis of the MIRR will cause $0.00 value to be lost.

WACC: 8.75%

Year

0

1

2

3

4

CFS −$1,100 $375 $375 $375 $375

CFL −$2,200 $725 $725 $725 $725

a. $32.12

b. $35.33

c. $38.87

d. $40.15

e. $42.16

107.

Yonan Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually

exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter

payback, some value may be forgone. How much value will be lost in this instance? Note that under some

conditions choosing projects on the basis of the shorter payback will not cause value to be lost.

WACC:

Year

10.25%

0

1

2

3

4

CFS

−$950

$500

$800

$0

CFL

−$2,100

$400

$800

$1,000

a. $24.14

b. $26.82

c. $29.80

d. $33.11

e. $36.42

CFS

$0

108.

Noe Drilling Inc. is considering Projects S and L, whose cash flows are shown below. These projects are

mutually

exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection

criterion, while the

CFO advocates the MIRR. If the decision is made by choosing the project with the higher

IRR rather than the one

with the higher MIRR, how much, if any, value will be forgone, i.e., what’s the NPV

of the chosen project versus

the maximum possible NPV? Note that (1) “true value” is measured by NPV, and

(2) under some conditions the

choice of IRR vs. MIRR will have no effect on the value lost.

WACC:

Year

7.00%

0

1

2

3

4

CFS

−$1,100

$550

$600

$100

CFL

−$2,750

$725

$800

$1,400

a. $185.90

b. $197.01

c. $208.11

d. $219.22

e. $230.32

CFS