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Session 12R - COMM308 AA Fall 2012

# Session 12R - COMM308 AA Fall 2012 - Review Questions...

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Review Questions

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Problem 17 (Final exam 2007, Q.17) The Canadian Space Agency is considering two mutually exclusive projects code named Mars and Venus. The Mars project has an internal rate of return (IRR) of 10% while the Venus project has an IRR of 8%. The cross-over rate is 6%. If the appropriate discount rate is 4%, which project(s) should the Canadian Space Agency accept: a)Mars only b)Venus only c)Mars and Venus d)Neither project The internal rate of return (IRR) is the discount rate that causes the NPV of the project to equal zero Cross over rate is a special discount rate at which the NPV of two projects cross Mutually exclusive projects are substitutes where the decision to accept one project automatically means all other substitute proposals are rejected
(\$4,000.00) (\$3,000.00) (\$2,000.00) (\$1,000.00) \$0.00 \$1,000.00 \$2,000.00 \$3,000.00 \$4,000.00 \$5,000.00 0% 10% 20% 30% 40% Discount rate NPV Project A Project B

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Venus: Green Mars: Red NPV Discount rate Mars IRR=10% NPV=0 at this rate Venus IRR=8% NPV=0 at this rate Cross over rate=6% NPVs are equal or both lines cross the same point Discount rate = 4% We are here so the higher NPV is the choice
Problem 18 (Final exam 2008, Q. 15) You have been asked to evaluate 2 pollution control devices. The wet scrub costs \$100 to set up and \$50 per year to operate. It must be completely replaced every 3 years, and it has no salvage value. The dry scrub device costs \$200 to set up and \$30 to operate. It lasts for 5 years and has no salvage value. Assuming that pollution control equipment is replaced as it wears out, which method do you recommend if the cost of capital is 10%? Assume the tax rate is zero. a)Dry scrub, the EANPV is -\$11.00 b)Wet scrub, the EANPV is -\$90.21 c)Dry scrub, the EANPV is -\$82.76 d)Wet scrub, the EANPV is -\$9.79 e)Dry scrub, the EANPV is -\$124.34 Equivalent Annual NPV (EANPV) approach compares projects by finding the NPV of the individual projects and then determining the amount of an annuity that is economically equivalent to the NPV generated by each project over its respective time horizon.

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