Firm could do with these cash flows would be to

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Financial Management: Theory & Practice
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Chapter 10 / Exercise 10-3
Financial Management: Theory & Practice
Brigham/Ehrhardt
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firm could do with these cash flows would be to replace money that has a cost of 10 percent? Finally, does this imply that the cost of capital is the correct rate to assume for the reinvestment of a project's cash flows? d.Construct NPV profiles for Plans A and B, identify each project's IRR, and indicate the crossover rate of return. 18.The Pinkerton Publishing Company is considering two mutually exclusive expansion plans. Plan A calls for the expenditure of $50 million on a large-scale, integrated plant which will pro- vide an expected cash flow stream of $8 million per year for 20 years. Plan B calls for the expenditure of$15 million to build a somewhat less efficient, more labor-intensive plant which has an expected cash How stream of $3.4 million per year for 20 years. The firm's cost of capital is 10 percent. a.Calculate each project's NPV and IRR. b.Set up a Project Δby showing the cash flows that will exist if the firm goes with the large plant rather than the smaller plant. What are the NPV and the IRR for this ProjectΔ? c.Graph the NPV profiles for Plan A, Plan B, and ProjectΔ. d.Give a logical explanation, based on reinvestment rates and opportunity costs, as to why the NPV method is better than the IRR method when the firm's cost of capital is constant at some value such as 10 percent. 19.The Ulmer Uranium Company is deciding whether or not it should open a strip mine, the net cost of which is $4.4 million. Net cash inflows are expected to be $17.7 million, all coming at the end of Year 1. The land must be returned to its natural state at a cost of $25 million, payableat the end of Year 2. a.Plot the project’s NPV profile. b.Should the project be accepted if r = 8%? If r = 14%? Explain your reasoning. c.Can you think of some other capital budgeting situations where negative cash flows during or at the end of the project's life might lead to multiple IRRs? d.What is the project's MIRR at r = 8%? At r = 14%? Does the MIRR method lead to the same accept/reject decision as the NPV method? 20.The Durst Development Company (DDC) has many excellent investment opportunities, but it has insufficient cash to undertake them all. Now DDC is offered the chance to borrow $2 million from the Rancho Palisades Retirement Fund at 1 0 percent, and the loan is to be repaid at the end of 1 year. Also, a "consulting fee" of $700,000 will be paid to Rancho Palisades' mayor at the end of 1 year for helping to arrange the credit. Of the $2 million received, $1 million will be used immediately to buy an old city-owned hotel and to convert it into a gambling casino. The other $1 million will be invested in other lucrative DDC projects that otherwise would have to be foregone because of a lack of capital. For 1 years, all cash generated by the casino will be plowed back into the casino project. At the end of the 1 years, the casino will be sold for $2 million. Assuming that (1) the deal has been worked out in the sunshine and is completely legal and (1) cash from other DDC Company operations will be available to make the
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Financial Management: Theory & Practice
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Chapter 10 / Exercise 10-3
Financial Management: Theory & Practice
Brigham/Ehrhardt
Expert Verified
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