Extra Practice Problems
1.
A firm with 14% cost of capital is evaluating two projects for this year’s capital
budget. Aftertax cash flows are generated at the end of each year, as follows:
Time
Project A
Project B
0
6,000
18,000
1
2,000
5,600
2
2,000
5,600
3
2,000
5,600
4
2,000
5,600
a.
Calculate NPV, IRR, payback and discounted payback for each project.
b.
Assuming the projects are independent which ones would you recommend?
c.
If the projects are mutually exclusive, which would you recommend?
d.
Notice that the projects have the same cash flow timing pattern. Why is there a
conflict between NPV and IRR?
2.
A company has 12% cost of capital and is considering two mutually exclusive
investments with the following net cash flows:
Time
Project A
Project B
0
300
405
1
387
134
2
193
134
3
100
134
4
600
134
5
600
134
6
850
134
7
180
0
a.
What is each project’s NPV?
b.
What is each project’s IRR?
c.
What is each project’s MIRR?
d.
Based on a, b and c, which projects would be selected? If the cost of capital were
18%, which project would be selected?
e.
What is each project’s MIRR at a cost of capital of 18%?
3.
A mining company is deciding whether to open a strip mine, which costs $2
million. Net cash inflows of $13 million would occur at the end of year 1. The
land must be returned to it’s natural state at a cost of $12 million, payable at the
end of year 2. This constitutes a situation with multiple IRR’s.
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Should the project be accepted if cost of capital = 10%? If cost of capital = 20%?
Explain your reasoning using both NPV and IRR criteria.
b.
What is the project’s MIRR at cost of capital = 10%? At cost of capital =20%?
Does MIRR lead to the same accept/reject decision for this project as the NPV
method?
4.
A store has 5 years remaining on its lease in a mall. Rent is $2,000 per month, 60
payments remain, and the next payment is due in 1 month. The mall’s owner
plans to sell the property in a year and wants rent at that time to be high so the
property will appear more valuable. Therefore, the store has been offered a “great
deal” (owner’s words) on a new 5 –year lease. The new lease calls for no rent for
9 months, then payments of $2,600 per month for the next 51 months. The lease
cannot be broken, and the store’s cost of capital is 12% (or 1 percent per month).
a.
Should the new lease be accepted?
b.
If the storeowner decided to bargain with the mall’s owner over the new
lease payment, what new lease payment would make the store owner
indifferent between the new and old leases?
c.
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 Spring '08
 Ajinka
 Accounting, Net Present Value

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