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Chapter 11 Review Session

Chapter 11 Review Session - Chapter 11 Review Session 2007...

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© 2007 Robert H. Smith School of Business University of Maryland “Chapter 11 Review Session”

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© 2007 Robert H. Smith School of Business University of Maryland Chapter 11 Review Session 1. Projects A and B each have an initial cost of \$5,000, followed by a series of positive cash inflows. Project A has total undiscounted cash inflows of \$12,000, while B has total undiscounted inflows of \$10,000. Further, at a discount rate of 10%, the two projects have identical NPVs. Which project’s NPV will be more sensitive to changes in the discount rate? Note that projects with steeper NPV profiles are more sensitive to discount rate changes. Project A Project B Both projects are equally sensitive to change in the discount rate since their NPVs are equal at all costs of capital. The solution cannot be determined unless the timing of the cash flows is known.
© 2007 Robert H. Smith School of Business University of Maryland Chapter 11 Review Session 1. A is correct. If we were to begin graphing NPV profiles for each of these projects, we would know two of the points for each project. The Y intercepts for projects A and B would be \$7,000 and \$5,000, respectively and the crossover would be 10%. So, Project A’s NPV profile would have the steeper slope and would be more sensitive to changes in the discount rate.

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© 2007 Robert H. Smith School of Business University of Maryland Chapter 11 Review Session 2. Which of the following is true? a. If a project has an IRR greater than zero, then taking on the project will increase the value of the company’s common stock because the project will make a positive contribution to net income. b.
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Chapter 11 Review Session - Chapter 11 Review Session 2007...

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