Principles of Corporate Finance_ 12th Edition

126 Part One Value

bre44380_ch05_105-131.indd 126 09/02/15 04:05 PM

5. IRR rule 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%?

c. The opportunity cost of capital is 20%. Is this an attractive project? Briefly explain.

6. IRR rule Consider projects Alpha and Beta:

The opportunity cost of capital is 8%.

Suppose you can undertake Alpha or Beta, but not both. Use the IRR rule to make the

choice. (Hint: What’s the incremental investment in Alpha?)

7. Capital rationing Suppose you have the following investment opportunities, but only
   $90,000 available for investment. Which projects should you take?

INTERMEDIATE

8. Payback Consider the following projects:

a. If the opportunity cost of capital is 10%, which projects have a positive NPV?

b. Calculate the payback period for each project.

Cash Flows ($)

C 0 C 1 C 2

• 100 + 200 – 75

Cash Flows ($)

Project C 0 C 1 C 2 IRR (%)

Alpha –400,000 +241,000 +293,000 21

Beta –200,000 +131,000 +172,000 31

Project NPV Investment

1 5,000 10,000

2 5,000 5,000

3 10,000 90,000

4 15,000 60,000

5 15,000 75,000

6 3,000 15,000

Cash Flows ($)

Project C 0 C 1 C 2 C 3 C 4 C 5

A –1,000 +1,000 0 0 0 0

B –2,000 +1,000 +1,000 +4,000 +1,000 +1,000

C –3,000 +1,000 +1,000 0 +1,000 +1,000