Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate Edition
IV. Capital Budgeting 9. Net Present Value and
Other Investment Criteria
(^336) © The McGraw−Hill
Companies, 2002
- Calculating NPV For the cash flows in the previous problem, suppose the
firm uses the NPV decision rule. At a required return of 11 percent, should the
firm accept this project? What if the required return was 21 percent? - Calculating NPV and IRR A project that provides annual cash flows of
$1,200 for nine years costs $6,000 today. Is this a good project if the required re-
turn is 8 percent? What if it’s 24 percent? At what discount rate would you be in-
different between accepting the project and rejecting it? - Calculating IRR What is the IRR of the following set of cash flows?
- Calculating NPV For the cash flows in the previous problem, what is the
NPV at a discount rate of zero percent? What if the discount rate is 10 percent?
If it is 20 percent? If it is 30 percent? - NPV versus IRR Bumble’s Bees, Inc., has identified the following two mutu-
ally exclusive projects:
a.What is the IRR for each of these projects? If you apply the IRR decision
rule, which project should the company accept? Is this decision necessarily
correct?
b.If the required return is 11 percent, what is the NPV for each of these proj-
ects? Which project will you choose if you apply the NPV decision rule?
c. Over what range of discount rates would you choose Project A? Project B?
At what discount rate would you be indifferent between these two projects?
Explain.
- NPV versus IRR Consider the following two mutually exclusive projects:
Sketch the NPV profiles for X and Y over a range of discount rates from zero to
25 percent. What is the crossover rate for these two projects?
- Problems with IRR Kong Petroleum, Inc., is trying to evaluate a generation
project with the following cash flows:
Year Cash Flow (X) Cash Flow (Y)
0 $4,000 $4,000
1 2,500 1,500
2 1,500 2,000
3 1,800 2,600
Year Cash Flow (A) Cash Flow (B)
0 $17,000 $17,000
1 8,000 2,000
2 7,000 5,000
3 5,000 9,000
4 3,000 9,500
Year Cash Flow
0 $4,000
1 1,500
2 2,100
3 2,900
306 PART FOUR Capital Budgeting
Basic
(continued)