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# 02 then choose project a if the required rate of

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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...
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