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?