U6 case

Rita (CHAO JUNG HSUAN)

A. (1)Analysis of potential additions to fixed assets. Long term-decisions, involve large

expenditures. (2) They calculate the risk involved in the cash flows. They also in tabour and the are
of return. They both consider if the present value of the inflows is greater than the present value of
the outflows which means net present value should be positive.

B. (1)Independent projects - if the cash flows if one are not affected by the acceptance of the
others, more than one project may be accepted.
Mutually exclusive projects- if the cash flows of one project can be adversely impacted by the
acceptance of the other, one of the two or more projects may be accepted.
(2) Normal cash flow– Cost (negative CF) followed by a series of positive cash inflows. One
change of signs.
Nonnormal cash flow – Two or more changes of signs. Most common: Cost (negative CF), then
string of positive CFs, then cost to close project. Nuclear power plant, strip mine.

n
CFt
C. (1)Sum of the NPVs of all cash inflows and outflows of a project: NPV = ∑ t
t =0 ( 1 + k )
(2) NPV = PV of inflows – Cost = Net gain in wealth
If projects are independent, accept if the project NPV > 0
If projects are mutually exclusive, accept projects with the highest positive NPV, those that add the
most value.
(3) Yes.The NPV of a project is dependent on the cost of capital used. Thus, if the cost of
capital changed, the NPV of each project would change. NPV declines as r increases,
and NPV rises as r falls.

 n
CFt
0=∑
D.(1)IRR is the discount rate that forces PV of inflows equal to cost, and the NPV = 0: t =0 ( 1 + IRR ) t

(2)They are the same thing. Think of a bond as a project. The YTM on the bond would be the IRR
of the “bond” project. 


(3) If IRR > WACC, the project’s return exceeds its costs and there is some return left over to boost
stockholders’ returns. If IRR > WACC, accept project. If IRR < WACC, reject project.
If projects are independent, accept both projects, as both IRR > WACC
If projects are mutually exclusive, accept S, because IRRs> IRRL

(4) IRR is independent of the WACC, so it doesn't change when the WACC changes

E.(1)Crossover Point = 8.7%

(2)If projects are independent, the two methods always lead to the same accept/reject decisions. If
projects are mutually exclusive,If WACC > crossover rate, the methods lead to the same decision
and there is no conflict.
If WACC < crossover rate, the methods lead to different accept/reject decisions. / No
F.(1)The underlying cause of ranking conflicts is the reinvestment rate assumption.
(2)The underlying cause of ranking conflicts is the reinvestment rate assumption.
All DCF methods implicitly assume that cash flows can be reinvested at some rate, regardless
of what is actually done with the cash flows.Discounting is the reverse of compounding.Since
compounding assumes reinvestment, so does discounting. NPV and IRR are both found by
discounting, so they both implicitly assume some discount rate.Inherent in the NPV calculation is
the assumption that cash flows can be reinvested at the project’s cost of capital, while the IRR
calculation assumes reinvestment at the IRR rate.

(3)Whether NPV or IRR gives better rankings depends on this has the better
reinvestment rate assumption. Normally, the NPV s assumption is better. The reason is
as follows:
A project’s cash inflows are generally used as substitutes for outside capital,
that is, projects
cash flows replace outside capital and, hence, save the firm the cost of
outside capital.
Therefore, in an opportunity cost sense, a project’s cash flows are
reinvested at the cost of capital.



G.(1)use excel -> MIRR L= 16.5%.
MIRR S= 16.9%

(2)MIRR does not always lead to the same decision as NPV when mutually exclusive projects are
being considered. In particular, small projects often have a higher MIRR, but a lower NPV, than
larger projects.Thus, MIRR is not a perfect substitute for NPV, and NPV remains the single best
decision rule.

H. (1)The number of years required to recover a project’s cost, or “How long does it take to get our
money back?” . Calculated by adding project’s cash inflows to its cost until the cumulative cash
flow for the project turns positive.

Payback = 2+30/80= 2.375 years / Payback = 1+30/50= 1.600 years

L S

(2)The rationale behind this is that the shorter the payback period, the greater the liquidity, and
the less risky the project. Advantages of the method include: it is simple to compute and easy to
understand and it handles investment risk effectively.
(3)the payback period pertains to the time period needed for the return on an investment to equal
the sum of the first investment. The discounted payback period also measures the time needed
to recover the original investment costs, but it also accounts for time value of money.
(4) It ignores the time value of money & It ignores the cash flows that occur after the payback
period.

I.(1) NPV= -386.78 / IRR=error / MIRR=5.6%

(2) Nonnormal /No, NPV is negative and MIRR < than WACC(10%)