02 then choose project a if the required rate of

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: required rate of return is less than 11.02%, then choose project B. 6.19 Let project A be Deepwater Fishing; let project B be New Submarine Ride. a. Project A: Year Discounted CF Cumulative CF 0 -$600,000 -$600,000 1 234,783 -365,217 2 264,650 -100,567 3 197,255 Discounted payback period of project A = 2 + $100,567 / $197,255 = 2.51 years Project B: Year 0 1 2 3 Discounted CF -$1,800,000 869,565 529,301 591,765 Cumulative CF -$1,800,000 -930,435 -401,134 b. c. Discounted payback period of project B = 2 + $401,134 / $591,765 = 2.68 years Project A should be chosen. IRR of project A: -$600,000 + $270,000 / (1 + r) + $350,000 / (1 + r)2 + $300,000 / (1 + r)3 = 0 IRR = r = 24.30% IRR of project B: -$1,800,000 + $1,000,000 /(1 + r) + $700,000 / (1 + r)2 + $900,000 / (1 + r)3 =0 IRR = r = 21.46% Based on the IRR rule, project A should be chosen since it has a greater IRR. Incremental IRR: Year 0 1 2 3 B-A -$1,200,000 $730,000 $350,000 $600,000 -$1,200,000 + $730,000 / (1 + r) + $350,000 / (1 + r)2 + $600,000 / (1 + r)3 = 0 Incremental IRR = r = 19.92% Since the incremental IRR is greater than the required rate of return, 15%, choose project B. B-70 Answers to End-of-Chapter Problems d. NPVA = -$600,000 + $270,000 / 1.15 + $350,000 / 1.152 + $300,000 / 1.153 = $96,687.76 NPVB = -$1,800,000 + $1,000,000 / 1.15 + $700,000 / 1.152 + $900,000 / 1.153 = $190,630.39 Since NPVB > NPVA, choose project B. Yes, the NPV rule is consistent with the incremental IRR rule. The IRR is the discount rate at which the NPV = 0 11 $100,000 1 + 8% $50,000 =0 1 - - -$600,000 + ( r - 8%) 1 + r (1 + r ) 11 IRR 18.56% Yes, the mine should be opened since its IRR exceeds its required return of 10%. 6.20 a. b. Answers to End-of-Chapter Problems B-71...
View Full Document

Ask a homework question - tutors are online