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Problem 11-23

Your division is considering two
projects. Its WACC is 10%, and the
projects’ after-tax cash flows (in millions

of dollars) would be:

Expected net cash flows

Time

Project A

Project B

0

($30)

($30)

1

$5

$20

2

$10

$10

3

$15

$8

4

$20

$6

1.
Calculate the projects’ NPVs, IRRs, MIRRs,
regular paybacks, and discounted paybacks.
2.
If the
two projects are independent, which project(s) should be chosen?
3.
If the
two projects are mutually exclusive and the WACC is 10%, which projects should
be chosen?
4.
Plot NPV
profiles for the two projects. Identify
the projects’ IRRs on the graph.
5.
If the
WACC were 5%, would this change your recommendation if the projects were
mutually exclusive? If the WACC were 15%, would this change your
recommendation? Explain your answers.
6.
The
“crossover rate” is 13.5252%.
Explain in words what this rate is and how it affects the choice between
mutually exclusive projects.
7.
Is it
possible for conflicts to exist between the NPV and IRR when independent
projects are being evaluated? Explain your answer.
8.
Now,
just look at the regular and discounted paybacks. Which project looks better when judged by the
paybacks?
9.
If the
payback were the only method a firm used to accept or reject projects, what
payback should it choose as the cutoff point, that is, reject projects if their
payouts are not below the chosen cutoff?
Is your selected cutoff based on some economic criteria or is it more
or less arbitrary? Are the cutoff
criteria equally arbitrary when firms use the NPV and/or the IRR as the
criteria?
10.
Define
the MIRR. What’s the difference between
the IRR and the MIRR, and which generally gives a better idea of the rate of
return on the investment in a project?
11. Why
do most academics and financial executives regard the NPV as being the single
best criterion, and better than the IRR?
Why do companies still calculate IRRs?

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