FIN3300 Solution Ch9 (M 0802)

# FIN3300 Solution Ch9 (M 0802) - Solution Chapter 9 Net...

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Chapter 9: Net Present Value and Other Investment Criteria Page 294-295 Questions: 14, 15, 16, 17 19 14. a. The equation for the NPV of the project is: NPV = –\$45,000,000 + \$78,000,000/1.1 – \$14,000,000/1.1 2 = \$13,482,142.86 The NPV is greater than 0, so we would accept the project. b. The equation for the IRR of the project is: 0 = –\$45,000,000 + \$78,000,000/(1+IRR) – \$14,000,000/(1+IRR) 2 From Descartes rule of signs, we know there are potentially two IRRs since the cash flows change signs twice. From trial and error, the two IRRs are: IRR = 53.00%, –79.67% When there are multiple IRRs, the IRR decision rule is ambiguous. Both IRRs are correct, that is, both interest rates make the NPV of the project equal to zero. If we are evaluating whether or not to accept this project, we would not want to use the IRR to make our decision. 15. The profitability index is defined as the PV of the cash inflows divided by the PV of the cash outflows. The equation for the profitability index at a required return of 10 percent is: PI = [\$7,300/1.1 + \$6,900/1.1 2 + \$5,700/1.1 3 ] / \$14,000 = 1.187 The equation for the profitability index at a required return of 15 percent is: PI = [\$7,300/1.15 + \$6,900/1.15 2 + \$5,700/1.15 3 ] / \$14,000 = 1.094 The equation for the profitability index at a required return of 22 percent is: PI = [\$7,300/1.22 + \$6,900/1.22 2 + \$5,700/1.22 3 ] / \$14,000 = 0.983 We would accept the project if the required return were 10 percent or 15 percent since the PI is greater than one. We would reject the project if the required return were 22 percent since the PI is less than one. 16.

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## This note was uploaded on 05/18/2011 for the course FINANCE Fin3300 taught by Professor Mosley during the Summer '10 term at CSU East Bay.

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FIN3300 Solution Ch9 (M 0802) - Solution Chapter 9 Net...

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