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# sols_1_ - FM212 Solutions to Class Exercises Lent Term...

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FM212 Solutions to Class Exercises Lent Term 2009/10 Solutions to Class Exercise 1 1. Mr. Cyrus Clops a. Because Project A requires a larger capital outlay, it is possible that Project A has both a lower IRR and a higher NPV than Project B. (In fact, NPV A is greater than NPV B for all discount rates less than 10 percent.) Because the goal is to maximize shareholder wealth, NPV is the correct criterion. b. To use the IRR criterion for mutually exclusive projects, calculate the IRR for the incremental cash flows: C 0 C 1 C 2 IRR A - B -200 +110 +121 10% Because the IRR for the incremental cash flows exceeds the cost of capital, the additional investment in A is worthwhile. c. 81.86 \$ (1.09) \$300 1.09 \$250 400 NPV 2 A = + + - = \$ \$79.10 (1.09) \$179 1.09 \$140 200 NPV 2 B = + + - = \$ 2. Mutually exclusive projects a. .82 0 10,000 8,182 10,000) ( 1.10 20,000 10,000 PI D = = - - + - = .59 0 20,000 11,818 20,000) ( 1.10 35,000 20,000 PI E = = - - + - = b. Each project has a Profitability Index greater than zero, and so both are acceptable projects. In order to choose between these projects, we must use incremental analysis. For the incremental cash flows: 0.36 10,000 3,636 10,000) ( 1.10 15,000 10,000 PI D E = = - - + - = -

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sols_1_ - FM212 Solutions to Class Exercises Lent Term...

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