chap006

The difference in scale is ignored apply the

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Unformatted text preview: scale is ignored. Apply the incremental IRR method. C0 B-A -\$95,000 C1 \$61,500 C2 \$61,500 f. g. NPV = -\$95,000 + \$61,500 / (1 + r) + \$61,500 / (1 + r)2 = 0 Incremental IRR = r = 19.09% If the discount rate is less than 19.09%, choose project B. Otherwise, choose project A. NPVA = -\$5,000 + \$3,500 / 1.15 + \$3,500 / 1.152 = \$689.98 NPVB = -\$100,000 + \$65,000 / 1.15 + \$65,000 / 1.152 = \$5,671.08 Choose project B. PVA = {\$5,000 / (0.12 - 0.04)} / 1.122 = \$49,824.61 PVB = (-\$6,000 / 0.12) / 1.12 = -\$44,642.86 The IRR for project C must solve {\$5,000 / (x - 0.04)} / (1 + x)2 + (-\$6,000 / x) / (1 + x) = 0 \$5,000 / (x - 0.04) - \$6,000 (1 + x) / x = 0 25 x2 + 3.17 x - 1 =0 x = {-3.17 - (110.0489)0.5} / 50 or {-3.17 + (110.0489)0.5} / 50 The relevant positive root is IRR = x = 0.1464 = 14.64% 6.12 a. b. c. To arrive at the appropriate decision rule, we must graph the NPV as a function of the discount rate. At a discount rate of 14.64% the NPV is zero. To determine if the graph is upward or downward sloping, check the NPV at another discount rate. At a discount rate of 10% the NPV is \$14,325.07 [= \$68,870.52 - \$54,545.54]. Thus, the graph of the NPV is downward sloping. From the discussion in the text, if an NPV graph is downward sloping, the project is an investing project. The correct decision rule for an investing project is to accept the project if the discount rate is below 14.64%. NPV \$14,325.07 0 10% 14.64% r Answers to End-of-Chapter Problems B-67 6.13 Generally, the statement is false. If the cash flows of project B occur early and the cash flows of project A occur late, then for a low discount rate the NPV of A can exceed the NPV of B. Examples are easy to construct. C0 C1 C2 IRR NPV @ 0% A: B: -\$1,000,000 -2,000,000 \$0 2,400,000 \$1,440,000 0 0.20 0.20 \$440,000 400,000 In one particular case, the statement is true for equally risky projects. If the lives of the two projects are equal and in every time period the cash flows of the project B are twice the cash flows of project A, then the NPV of project B will be twice as great as the NPV of project A for any discount rate between 0% and 20%. 6.14 a. b. NPV = \$756.57 - \$5...
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This note was uploaded on 05/07/2010 for the course FIN 302 taught by Professor Corporationfinance during the Spring '10 term at Uni Potsdam.

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