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Question 1:
Score 0.5/1
Your response
Correct response
Calculating Payback
Offshore Drilling Products, Inc., imposes a payback cutoff of 3 years for its international investment projects.
Suppose the company has the following two projects available. Project A has payback period of
3
(0%)
years, while project B has a payback period of
4
(0%) years. Using only the payback cutoff of 3 years, the
company should
accept
(25%) project A and
reject
(25%) project B.
(Round your answers to 2 decimal
places.)
Year
Cash Flow (A)
Cash Flow (B)
0
–$ 50,000
–$
422,000
1
34,000
11,000
2
15,000
26,000
3
10,000
33,000
4
1,000
410,000
Calculating Payback
Offshore Drilling Products, Inc., imposes a payback cutoff of 3 years for its international investment
Suppose the company has the following two projects available. Project A has payback period of
2.1
tolerance of ± 1.0%
years, while project B has a payback period of
3.86 with a toler
± 1.0%
years. Using only the payback cutoff of 3 years, the company should
accept
project A and
project B.
(Round your answers to 2 decimal places.)
Year
Cash Flow (A)
Cash Flow (B)
0
–$ 50,000
–$
422,000
1
34,000
11,000
2
15,000
26,000
3
10,000
33,000
4
1,000
410,000
Total grade:
0.0×1/4 + 0.0×1/4 + 1.0×1/4 + 1.0×1/4 = 0% + 0% + 25% + 25%
Feedback:
Project A has cash flows of:
Cash flows = $34,000 + 15,000
Cash flows = $49,000
during the first 2 years. The cash flows are still short by $1,000 of recapturing the initial investment, so the
payback for Project A is:
Payback = 2 + ($1,000 / $10,000)
Payback = 2.1 years
Project B has cash flows of:
Cash flows = $$11,000 + 26,000 + 33,000
Cash flows = $70,000
during the first 3 years. The cash flows are still short by $352,000 of recapturing the initial investment, so the
payback for Project B is:
Payback = 3 + ($352,000 / $410,000)
Payback = 3.86 years
Using the payback criterion and a cutoff of 3 years, accept project A and reject project B.
Question 2:
Score 0.5/1
Your response
Correct response
Calculating IRR
A firm evaluates all of its projects by applying the IRR rule. The IRR for the following project is
24.25
(0%) percent. If the required return is 27 percent, the firm should
reject
(50%) the project.
(Input
answer as a percent rounded to 2 decimal places, without the percent sign.)
Year
Cash Flow
0
–$ 32,816
1
20,000
2
17,000
3
9,000
Calculating IRR
A firm evaluates all of its projects by applying the IRR rule. The IRR for the following project is
21.
tolerance of ± 1.0%
percent. If the required return is 27 percent, the firm should
reject
the pro
answer as a percent rounded to 2 decimal places, without the percent sign.)
Year
Cash Flow
0
–$ 32,816
1
2
0
,
0
0
0
2
1
7
,
0
0
0
3
9
,
0
0
0
Total grade:
0.0×1/2 + 1.0×1/2 = 0% + 50%
Feedback:
The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equation that defines the IRR
for this project is:
0 = – $32,816 + $20,000/(1+IRR) + $17,000/(1+IRR)
2
+ $9,000/(1+IRR)
3
Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that:
IRR = 21.9%
Since the IRR is less than the required return, we would reject the project.
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 Spring '07
 ANDELIN,STEVENLE
 Corporate Finance

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