This preview shows pages 1–2. Sign up to view the full content.

CHAPTER 9 B-165 B: \$40,000 = \$19,000/(1+IRR) + \$12,000/(1+IRR) 2 + \$18,000/(1+IRR) 3 + \$10,500/(1+IRR) 4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 19.50% IRR decision rule implies we accept project B because IRR for B is greater than IRR for A. e. The profitability index for each project is: A: PI = (\$20,000/1.15 + \$50,000/1.15 2 + \$50,000/1.15 3 + \$390,000/1.15 4 ) / \$300,000 = 1.037 B: PI = (\$19,000/1.15 + \$12,000/1.15 2 + \$18,000/1.15 3 + \$10,500/1.15 4 ) / \$40,000 = 1.086 Profitability index criterion implies accept project B because its PI is greater than project A’s. f. In this instance, the NPV criteria implies that you should accept project A, while profitability index, payback period, discounted payback, and IRR imply that you should accept project B. The final decision should be based on the NPV since it does not have the ranking problem associated with the other capital budgeting techniques. Therefore, you should accept project A. 18. At a zero discount rate (and only at a zero discount rate), the cash flows can be added together across time. So, the NPV of the project at a zero percent required return is: NPV = –\$684,680 + 263,279 + 294,060 + 227,604 + 174,356 = \$274,619 If the required return is infinite, future cash flows have no value. Even if the cash flow in one year is \$1 trillion, at an infinite rate of interest, the value of this cash flow today is zero. So, if the future cash flows have no value today, the NPV of the project is simply the cash flow today, so at an infinite interest rate: NPV = –\$684,680 The interest rate that makes the NPV of a project equal to zero is the IRR. The equation for the IRR of this project is: 0 = –\$684,680 + \$263,279/(1+IRR) + \$294,060/(1+IRR) 2 + \$227,604/(1+IRR) 3 + 174,356/(1+IRR) 4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 16.23%

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.