Info

-$4,000,000 $2,000,000 $1,500,000 $ 1,250,000 $1,000,000

-$4,000,000 $1,000,000 $1,500,000 $1,700,000 $2,400,000

a. Estimate the net present value of each project, assuming a cost of capital of 10%. Which is the better project?

b. Estimate the internal rate of return for each project. Which is the better project?

c. What reinvestment rate assumptions are made by each of these rules? Can you show the effect on future cash flows of these assumptions?

d. What is the modified internal rate of return on each of these projects?

12. You have a project that does not require an initial investment but has its expenses spread over the life of the project. Can the IRR be estimated for this project? Why or why not?

13. Businesses with severe capital rationing constraints should use IRR more than NPV. Do you agree? Explain.

14. You have to pick between three mutually exclusive projects with the following cash flows to the firm:

The cost of capital is 12%.

a. Which project would you pick using the net present value rule?

b. Which project would you pick using the internal rate of return rule?

c. How would you explain the differences between the two rules? Which one would you rely on to make your choice?

Year Project A

15. You are analyzing an investment decision, in which you will have to make an initial investment of $10 million and you will be generating annual cash flows to the firm of $2 million every year, growing at 5% a year, forever.

a. Estimate the NPV of this project, if the cost of capital is 10%.

b. Estimate the IRR of this project.

16. You are analyzing a project with a 30-year lifetime, with the following characteristics:

• The project will require an initial investment of $20 million and additional investments of $ 5 million in year 10 and $ 5 million in year 20.

• The project will generate earnings before interest and taxes of $3 million each year. (The tax rate is 40%.)

• The depreciation will amount to $500,000 each year, and the salvage value of the equipment will be equal to the remaining book value at the end of year 30.

a. Estimate the net present value of this project.

b. Estimate the internal rate of return on this project. What might be some of the problems in estimating the IRR for this project?

17. You are trying to estimate the NPV of a 3-year project, where the discount rate is expected to change over time.

Year

Cash Flow to Firm

Discount Rate

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