Topic 4 FINC 2011 Tutorial Solutions

# Topic 4 FINC 2011 Tutorial Solutions - FINC 2011 Corporate...

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FINC 2011 Corporate Finance 1 Tutorial Questions and Solutions Topic 4 – Capital Budgeting Chapter 4 PQ 5 You   are   evaluating   two   capital   projects,   X   and   Y,   only   one   of   which   can   be  implemented.  The projects have the following IRR and NPV (calculated at the firm’s  cost of capital). Project X Project Y IRR 12% 17.5% NPV \$140,000 \$75,000 (a) Within what range of values does the firm’s cost of capital lie? (b) What characteristics of the cash flows associated with these two projects might give rise to this type of relationship between the IRR and the NPV? (c) Which project should be chosen? A N S W E R (a) The firm’s cost of capital must be less than 12%, because both projects have a positive NPV, and the lowest internal rate of return is 12%. Therefore the range must be 0% to 12% (b) Project X is probably a bigger project, because although it has a lower internal rate of return it has a greater NPV. (c) I would choose project X, because it has the higher NPV. PQ 9 You are evaluating two mutually exclusive projects, project X and project Y.  The cost   of capital is 14%, and the projected cash flows of these two projects are as follows: Year 0 1 2 3 4 5 Project X -3,000 1,200 1,500 450 600 1,200 Project Y -4,500 1,797 1,200 1,800 1,050 1,200 (a) Based on the NPV technique, which project should be accepted?

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Based on the IRR technique, which project should be accepted? (c) Draw the NPV profiles of these two projects, and discuss why the NPV and IRR techniques provide different conclusions? A N S W E R (a) ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 55 . 459 \$ 14 . 1 1200 14 . 1 1050 14 . 1 1800 14 . 1 1200 14 . 1 1797 4500 06 . 489 \$ 14 . 1 1200 14 . 1 600 14 . 1 450 14 . 1 1500 14 . 1 1200 3000 1 5 4 3 2 5 4 3 2 0 = + + + + + - = = + + + + + - = + = = Y X n t t t NPV NPV k CF NPV Project X should be accepted. (b) ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 % 49 . 18 0 \$ 1 1200 1 1050 1 1800 1 1200 1 1797 4500 % 22 . 21 0 \$ 1 1200 1 600 1 450 1 1500 1 1200 3000 0 1 5 4 3 2 5 4 3 2 0 = = + + + + + + + + + + - = = = + + + + + + + + + + - = = + = = X Y X X n t t t IRR IRR IRR IRR IRR IRR NPV IRR IRR IRR IRR IRR IRR NPV IRR CF NPV Project X should be accepted. (c)
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## This note was uploaded on 08/22/2011 for the course FINC 2011 taught by Professor Craigmellare during the Three '10 term at University of Sydney.

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Topic 4 FINC 2011 Tutorial Solutions - FINC 2011 Corporate...

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