8-1 Solutions to Chapter 8 Net Present Value and Other Investment ...

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Chapter 08 - Net Present Value and Other Investment Criteria5. No. Even though project B has the higher IRR, its NPV is lower than that of project Awhen the discount rate is lower (as in Problem 1) and higher when the discount rate ishigher (as in Problem 3). This example shows that the project with the higher IRR isnot necessarily better. The IRR of each project is fixed, but as the discount rateincreases, project B becomes relatively more attractive compared to project A. This isbecause B’s cash flows come earlier, so the present value of these cash flows decreasesless rapidly when the discount rate increases.Est time: 01–056. The profitability indexes are as follows:Project A: $48.20/$200 = 0.2410Project B: $44.37/$200 = 0.2219In this case, with equal initial investments, both the profitability index and NPVgive projects the same ranking. This is an unusual case, however, since it is rare forthe initial investments to be equal.Est time: 01–057. Project A has a payback period of $200/$80 = 2.5 years.Project B has a payback period of 2 years.Est time: 01–058. No. Despite its longer payback period, Project A may still be the preferred project,for example, when the discount rate is 11% (as in Problems 1 and 2). As inProblem 5, you should note that the payback period for each project is fixed but theNPV changes as the discount rate changes. The project with the shorter paybackperiod need not have the higher NPV.Est time: 01–058-2
Chapter 08 - Net Present Value and Other Investment Criteria9. NPV = $3,000 + [$800 annuity factor (10%, 6 years)] 1 1 = – $3,000 $800 $484. 216 0.100.10(1.10) At the 10% discount rate, the project is worth pursuing.IRR = discount rate (r), which is the solution to the following equation:11 $800 $3,0006(1 ) r = IRR = 15.34%rr r You can solve for IRR using a financial calculator by entering PV = ()3,000; n = 6;FV = 0; PMT = 800; then compute i.Since the IRR is 15.34%, this is the highest discount rate before project NPVturns negative.Est time: 01–0510. Payback period = $2,500/$600 = 4.167 yearsThis is less than the cutoff, so the firm would accept the project.r = 2% NPV = $2,500 + [$600 annuity factor (2%, 6 years)] 1 1 = – $2,500 $600 $860. 866 0.020.02(1.02) r = 12% NPV = $2,500 + [$600 annuity factor (12%, 6 years)] 1 1 = – $2,500 $600 $33.166 0.120.12 (1.12) If r = 2%, the project should be pursued; at r = 12%, it should not be.Est time: 06–10$3,000 $3,000 $5,000 $5,00011. NPV $10,000 $2,680. 382 341.09 1.09 1.09 1.09Profitability index = NPV/investment = 0.2680Est time: 01–058-3
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8-1 Solutions to Chapter 8 Net Present Value and Other Investment ...

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