Chapter 5 Net Present Value and Other Investment Criteria 127
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c. Which project(s) would a firm using the payback rule accept if the cutoff period were
three years?
d. Calculate the discounted payback period for each project.
e. Which project(s) would a firm using the discounted payback rule accept if the cutoff
period were three years?
- Payback and IRR rules Respond to the following comments:
a. “I like the IRR rule. I can use it to rank projects without having to specify a discount rate.”
b. “I like the payback rule. As long as the minimum payback period is short, the rule makes
sure that the company takes no borderline projects. That reduces risk.”
- IRR Calculate the IRR (or IRRs) for the following project:
For what range of discount rates does the project have positive NPV?- IRR rule Consider the following two mutually exclusive projects:
a. Calculate the NPV of each project for discount rates of 0%, 10%, and 20%. Plot these on a
graph with NPV on the vertical axis and discount rate on the horizontal axis.
b. What is the approximate IRR for each project?
c. In what circumstances should the company accept project A?
d. Calculate the NPV of the incremental investment (B – A) for discount rates of 0%, 10%,
and 20%. Plot these on your graph. Show that the circumstances in which you would
accept A are also those in which the IRR on the incremental investment is less than the
opportunity cost of capital.
- IRR rule Mr. Cyrus Clops, the president of Giant Enterprises, has to make a choice
between two possible investments:
The opportunity cost of capital is 9%. Mr. Clops is tempted to take B, which has the higher IRR.a. Explain to Mr. Clops why this is not the correct procedure.
b. Show him how to adapt the IRR rule to choose the best project.
c. Show him that this project also has the higher NPV.
C 0 C 1 C 2 C 3- 3,000 +3,500 +4,000 –4,000
Cash Flows ($ thousands)
Project C 0 C 1 C 2 IRR (%)A – 400 + 250 + 300 23
B – 200 + 140 + 179 36Cash Flows ($)
Project C 0 C 1 C 2 C 3
A – 100 + 60 + 60 0
B – 100 0 0 + 140