CH08Problems - Understanding Financial Management A...

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1 Understanding Financial Management: A Practical Guide Problems and Answers Chapter 8 Capital Budgeting 8.2 – 8.8 Capital Budgeting Techniques (NPV, PI, IRR, MIRR, PP, and DPP) 1. Fair Trade Tea Company (FTTC) is considering investing $200,000 to expand its operations. The firm’s required rate of return is 12% and the firm expects to reinvest any cash inflows at this rate. Management has set the maximum payback period as 3 years and the maximum discounted payback period at 4 years. The firm estimates that year-end cash flows will be as follows: Fair Trade Tea Company Net Cash Flows Year 0 1 2 3 4 5 Net cash flow -$200,000 $50,000 $54,000 $60,000 $68,000 $75,000 Using each of the follow techniques, should the firm accept the project? Why or why not? A. Net present value B. Profitability index C. Internal rate of return D. Modified internal rate of return E. Payback period F. Discounted payback period 2. Coltrane Recordings is considering investing in a new project with an unconventional cash flow pattern. The company’s cost of capital is 13% and the firm expects to reinvest any cash inflows at this rate. Management has set the maximum discounted payback period at 4 years. The initial investment and year-end cash flows are listed below. Coltrane Recordings Net Cash Flows Year 0 1 2 3 4 5 Net cash flow -$500,000 $160,000 $180,000 $-60,000 $220,000 $260,000 Using each of the following discounted cash flow techniques, should the firm accept the project? Why or why not? A. Net present value B. Profitability index C. Internal rate of return D. Modified internal rate of return F. Discounted payback period
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2 8.9 Mutually Exclusive Projects 3. Conglomerate Inc. is considering two mutually exclusive projects with the following estimated year-end cash flows: Year Project A Project B 0 -$350,000 -$350,000 1 90,000 170,000 2 110,000 150,000 3 140,000 120,000 4 210,000 100,000 The firm’s cost of capital is 15% and the firm expects to reinvest any cash inflows at this rate. Management set the maximum payback period at 3 years and the maximum discounted payback period at 3.5 years. Using each of the follow techniques, which project is preferable? Why? A. Net present value B. Profitability index C. Internal rate of return D. Modified internal rate of return E. Payback period F. Discounted payback period 4. Waldorf Suppliers is evaluating two mutually exclusive machines -- Model 300 or Model 100. The firm requires an 11% rate of return and has sufficient financing to undertake either project. Analysts had done some preliminary analysis of these two projects as shown below. Mutually Exclusive Projects – Model 100 and Model 300 Year Model 300 Rank Model 100 Rank 0 -$350,000 -$200,000 1 120,000 70,000 2 120,000 70,000 3 120,000 70,000 4 120,000 70,000 NPV @ 11% $22,293 1 $17,171 2 PI $1.06 2 $1.09 1 IRR 13.95% 2 14.96% 1 MIRR @ 11% 12.73% 2 13.31% 1 A. Why does a conflict exist between the rankings or Model 300 and Model 100? B. Based solely on the information provided, which project is preferable? Why? 5. Dyna Corp. can undertake one of two mutually exclusive projects – Project X or Project Y.
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This note was uploaded on 04/17/2008 for the course FIN 134 taught by Professor Pope during the Spring '08 term at CSU Sacramento.

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CH08Problems - Understanding Financial Management A...

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