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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 Fall '10
 MUNGOWILSON
 Net Present Value, Internal rate of return, Exercises Lent Term, Class Exercises Lent

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