Chapter12solutions

# Chapter12solutions - Chapter 12 Capital Budgeting Decision...

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Chapter 12 Capital Budgeting: Decision Criteria ANSWERS TO END-OF-CHAPTER QUESTIONS 12-3 The NPV is obtained by discounting future cash flows, and the discounting process actually compounds the interest rate over time. Thus, an increase in the discount rate has a much greater impact on a cash flow in Year 5 than on a cash flow in Year 1. 12-4 This question is related to Question 12-3 and the same rationale applies. With regard to the second part of the question, the answer is no; the IRR rankings are constant and independent of the firm's cost of capital. 12-5 The NPV and IRR methods both involve compound interest, and the mathematics of discounting requires an assumption about reinvestment rates. The NPV method assumes reinvestment at the cost of capital, while the IRR method assumes reinvestment at the IRR. MIRR is a modified version of IRR which assumes reinvestment at the cost of capital. 12-6 Generally, the failure to employ common life analysis in such situations will bias the NPV against the shorter project because it "gets no credit" for profits beyond its initial life, even though it could possibly be "renewed" and thus provide additional NPV. SOLUTIONS TO END-OF-CHAPTER PROBLEMS 12-1 NPV = -\$52,125 + \$12,000[(1/I)-(1/(I*(1+I) N )] = -\$52,125 + \$12,000[(1/0.12)-(1/(0.12*(1+0.12) 8 )] = \$7,486.68. Financial calculator: Input the appropriate cash flows into the cash flow register, input I = 12, and then solve for NPV = \$7,486.68. 12-2 Financial calculator: Input the appropriate cash flows into the cash flow register and then solve for IRR = 16%.

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12-3 MIRR: PV Costs = \$52,125. FV Inflows: PV FV 0 1 2 3 4 5 6 7 8 | | | | | | | | | 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 13,440 15,053 16,859 18,882 21,148 23,686 26,528 52,125 MIRR = 13.89% 147,596 Financial calculator: Obtain the FVA by inputting N = 8, I/YR = 12, PV = 0, PMT = 12000, and then solve for FV = \$147,596. The MIRR can be obtained by inputting N = 8, PV = -52125, PMT = 0, FV = 147596, and then solving for I = 13.89%. 12-4 PV = \$12,000[(1/I)-(1/(I*(1+I) N )] = \$12,000[(1/0.12)-(1/(0.12*(1+0.12) 8 )] = \$59,611.68. Financial calculator: Find present value of future cash flows by inputting N = 8, I/YR = 12, PMT = -12000, FV = 0, then solve for PV = \$59,611.68. PI = PV of future cash flows / Initial cost = \$59,611.68/\$52,125 = 1.14. 12-5 Year CF Cumulative CF 0 -52,125 -52,125 1 12,000 -40,125 2 12,000 -28,125 3 12,000 -16,125 4 12,000 -4,125 5 12,000 7,875 6 12,000 19,875 7 12,000 31,875 8 12,000 43,875 12%
The cumulative cash flows turns positive in Year 5, so the payback will be 4 plus the part of Year 5 that is required to return the investment: Payback = 4 + (\$4,125/\$12,000) = 4.34. Because the future cash flows are identical, we can also find the payback period by

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Chapter12solutions - Chapter 12 Capital Budgeting Decision...

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