Intermediate Financial Management

Intermediate Financial Management, 2nd Assignment

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1. (A) what is meant by the term “mutually exclusive projects”?

(B) Explain why the IRR decision rule could give the wrong result when comparing mutually exclusive projects.

2. The following net cash flows relate to two projects:



NET CASH FLOWS (IN $ 1,000)

YEAR PROJECT A PROJECT B

0 -60 -72

1 20 45

2 20 22

3 20 20

4 20 13

5 20 13

6 20 13
  1. Calculate the NPVs for each project, assuming 10% cost of capital.

(ii) Assuming that the two projects are independent, would you accept them if the cost of capital is 15%?

(iii) What is the IRR of each project?

  1. Which of the two projects would you prefer if they are mutually exclusive, given a 15% discount rate?
  2. A firm has a capital budget of $100 which must be spent on one of two projects, each requiring a present outlay of $100. Project A yields a return of $120 after one year, whereas Project B yields $201.14 after 5 years. Calculate:
  1. The NPV of each project using a discount rate of 10%;
  2. The IRR of each project.

What are the project rankings on the basis of these two investment decision rules? Suppose that you are told that the firm’s reinvestment rate is 12%, which project should the firm choose?

  1. A firm has a capital budget of $100 which must be spent on one of two projects, with any unspent balance being placed in a bank deposit earning 15%. Project A involves a present outlay of $100 and yields $321.76 after 5 years. Project B involves a present outlay of $40 and yields $92 after one year. Calculate:
  1. The IRR of each project;
  2. The B/C ratio of each project, using a 15% discount rate.

What are the project rankings on the basis of these investment decision rules? Suppose that if Project B is undertaken its benefit can be reinvested at 17%; what project should the firm choose? Show your calculations (spreadsheet printout is acceptable as long as entries are clearly labelled).

  1. A firm has a capital budget of $30,000 and is considering three possible independent projects. Project A has a present outlay of $12,000 and yields $4, 281 per annum for 5 years. Project B has a present outlay of $10,000 and yields $4,184 per annum for 5 years. Project C has a present outlay of $17,000 and yields $5,802 per annum for 10 years. Funds which are not allocated to one of the projects can be placed in a bank deposit where they will earn 15%.
  1. Identify six combinations of project investments and a bank deposit which exhaust the budget.
  2. Which of the above combinations should the firm choose:
  1. When the reinvestment rate is 15%?
  2. When the reinvestment rate is 20%?

Explain your answer and show your calculations (spreadsheet printout is acceptable as long as entries are clearly labelled).

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