Below are the cash flows for two for two mutually

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Fundamentals of Financial Management
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Chapter 21 / Exercise 05
Fundamentals of Financial Management
Brigham
Expert Verified
9. Below are the cash flows for two for two mutually exclusive projects. The projects’ discount rate is 10%. Project C 0 C 1 C 2 C 3 A -18 10 10 10 B -50 25 25 25 Which of the following statements is/are true? A) Project A should be chosen because it has the higher NPV. B) Project A should be chosen because it has the higher IRR. C) If funds are limited, Project B should be chosen because it has the higher profitability index. D) If the firm has unlimited funds, both projects should be chosen. E) None of the above statements is true. Detailed Solution E: NPV A = –18 + 10 annuity factor(10%, 3 periods) = $ 6.87 NPV B = –50 + 25 annuity factor(10%, 3 periods) =$12.17 Thus Project B has the higher NPV if the discount rate is 10%. Project A has the higher profitability index. Invest Profitability Index Project PV ment NPV (= NPV/Investment) A 24.87 18 6.87 0.38 B 62.17 50 12.17 0.24
A firm with a limited amount of funds available should choose Project A since it has a higher profitability index of 0.38, i.e., a higher “bang for the buck.” For a firm with unlimited funds , the possibilities are:
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Fundamentals of Financial Management
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Chapter 21 / Exercise 05
Fundamentals of Financial Management
Brigham
Expert Verified
10. Sequel Catering is considering a second store that has an up-front cost of $X. The project will generate a positive cash flow of $65,000 a year. Assume that these cash flows are paid at the end of each year and that the project will last for 20 years. Sequel uses a 9% annual discount rate. The project has a 12 percent IRR. What is the project's NPV? A
11. What is the amount of operating cash flow for a firm with $500,000 profit before tax, $100,000 depreciation expense, and a 35% corporate tax rate?
12.An investment today of $25,000 promises to return $10,000 annually for the next three years. What is the approximate real rate of return on this investment if inflation averages 6 percent annually during the 3 years? A) 3.5 % B) 9.7 % C) 14.0 % D) 20.0 % E) 21.4 % Solving with financial calculator, the IRR = 9.701%. Then, 1.09701/1.06 = 1.0349 or approx 3.5% real return.

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