project’s IRR. ____ 4. If a project’s NPV exceeds its IRR‚ then the project should be accepted. ____ 5. Conflicts between two mutually exclusive projects‚ where the NPV method chooses one project but the IRR method chooses the other‚ should generally be resolved in favor of the project with the higher NPV. ____ 6. The NPV method’s assumption that cash inflows are reinvested at the cost of capital is more reasonable than the IRR’s assumption that cash flows are reinvested at the IRR. This is an
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its IRR‚ then the project should be accepted. a. True b. False ANSWER: False 5. Conflicts between two mutually exclusive projects occasionally occur‚ where the NPV method ranks one project higher but the IRR method puts the other one first. In theory‚ such conflicts should be resolved in favor of the project with the higher NPV. a. True b. False ANSWER: True 6. Conflicts between two mutually exclusive projects occasionally occur‚ where the NPV method ranks one project higher but the IRR method
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Solutions to Problems Note to instructor: In most problems involving the IRR calculation‚ a financial calculator has been used. P9-1. LG 1: Payback period Basic a. $42‚000 ÷ $7‚000 = 6 years b. The company should accept the project‚ since 6 < 8. P9-2. LG 1: Payback comparisons Intermediate a. Machine 1: $14‚000 ÷ $3‚000 = 4 years‚ 8 months Machine 2: $21‚000 ÷ $4‚000 = 5 years‚ 3 months b. Only Machine 1 has a payback faster than 5 years and is acceptable. c. The firm will accept the first
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future Should we build this plant? All rights reserved - Christopher B. Alt 2 Key Steps in Capital Budgeting Estimate CFs (inflows & outflows) Assess riskiness of CFs Determine the appropriate cost of capital Find NPV and/or IRR Accept if NPV > 0 and/or IRR > WACC All rights reserved - Christopher B. Alt 3 Independent vs. Mutually Exclusive Projects Independent projects: if the cash flows of one are unaffected by the acceptance of the other Mutually exclusive projects: if the
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INTRODUCTION TO CAPITAL BUDGETING Overview 159 7.1 The NPV Rule for Judging Investments and Projects 159 7.2 The IRR Rule for Judging Investments 161 7.3 NPV or IRR‚ Which to Use? 162 7.4 The “Yes–No” Criterion: When Do IRR and NPV Give the Same Answer? 163 7.5 Do NPV and IRR Produce the Same Project Rankings? 164 7.6 Capital Budgeting Principle: Ignore Sunk Costs and Consider Only Marginal Cash Flows 168 7.7 Capital Budgeting Principle: Don’t Forget the Effects of Taxes—Sally and Dave’s
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to the share price or share value. The Internal Rate of Return of these entire projects are below the prototype store IRR which is a benchmark project. The IRR is an alternative to NPV however if the NPV is positive and the IRR is not what is desired‚ the NPV may supersede in making an investment decision. The IRR is what is expected based on internal factors. Projects with a low IRR may be funded through debt
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BenefitCost/Profitability Index Ratio IRR Capital Budget Techniques Accounting Rate of Return Non Discounted Payback Period Internal Rate of Return The rate at which the net present value of cash flows of a project is zero‚ I.e.‚ the rate at which the present value of cash inflows equals initial investment Project’s promised rate of return given initial investment and cash flows. Consistent with wealth maximization Accept a project if IRR ≥ Cost of Capital Question
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point of accepting this project. #5 Consider a project with the following cash flows: a. How many internal rates of return does this project have? b. Which of the following numbers is the project IRR: (i) -50%; (ii) -12%; (iii) +5%; (iv)+50%? As calculated in problem “a”‚ the project IRRs are (i) -50% &(iv)+50%. c. The
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Integrated Case 11-24 Allied Components Company Basics of Capital Budgeting You recently went to work for Allied Components Company‚ a supplier of auto repair parts used in the after-market with products from Daimler‚ Chrysler‚ Ford‚ and other automakers. Your boss‚ the chief financial officer (CFO)‚ has just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm’s ignition system line; it would take some time to build up the market for this
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required rate of return or cost of capital in capital budgeting. Then‚ find the PV of expected cash flows and the asset’s rate of return. If the PV of the inflows is greater than PV of outflows (NPV is positive)‚ or if the calculated rate of return (IRR) is higher than the project cost of capital‚ accept the project. Question b What is the difference between independent and mutually exclusive projects? Between normal and non-normal projects? Independent projects mean a company can select one or
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