Chapter 10 Solutions

CAPITAL BUDGETING PROBLEMS: CHAPTER 10Answers to Warm-Up Exercises E10-1. Answer: Payback period The payback period for Project Hydrogen is 4.29 years. The payback period for Project Helium is 5.75 years. Both projects are acceptable because their payback periods are less than Elysian Fields’ maximum payback period criterion of 6 years. NPV E10-2. Answer: Year 1 2 3 4 5 Cash Inflow $400,000 375,000 300,000 350,000 200,000 Total $1,389,677.35 Present Value $ 377,358.49 333,748.67 251,885.78 277,232.78 149,451.63 $1,389,677.35 NPV $1,250,000 $139,677.35 Herky Foods should acquire the new wrapping machine. CAPITAL BUDGETING PROBLEMS: CHAPTER 10 E10-3: Answer: NPV comparison of two projects Project Kelvin Present value of expenses Present value of cash inflows PV) NPV –$45,000 51,542 (PMT $20,000, N $ 6,542 3, I 8, Solve for Project Thompson Present value of expenses $275,000 Present value of cash inflows 277,373 (PMT $60,000, N 6, I 8, Solve for PV) NPV $ 2,373 Based on NPV analysis, Axis Corporation should choose an overhaul of the existing system. E10-4: Answer: IRR You may use a financial calculator to determine the IRR of each project. Choose the project with the higher IRR. Project T-Shirt PV 15,000, N Solve for I IRR 39.08% 4, PMT 8,000 Project Board Shorts PV 25,000, N 5, PMT 12,000 Solve for I IRR 38.62% Based on IRR analysis, Billabong Tech should choose project T-Shirt. E10-5: Answer: NPV Note: The IRR for Project Terra is 10.68% while that of Project Firma is 10.21%. Furthermore, when the discount rate is zero, the sum of Project Terra’s cash flows exceed that of Project Firma. Hence, at any discount rate that produces a positive NPV, Project Terra provides the higher net present value. Payback comparisons LG 2.000 6 years b.000 $4.000 $3. 3 months b. The firm will accept the first machine because the payback period of 4 years. c. .CAPITAL BUDGETING PROBLEMS: CHAPTER 10  Solutions to Problems Note to instructor: In most problems involving the IRR calculation.000) less than Machine 2. Basic a.000 $21. In this case. 8 months is less than the 5-year maximum payback required by Nova Products.000 $7. a financial calculator has been used. financial calculator worksheet keystrokes are provided. Payback period LG 2. Machine 1: $14.000 ($80. Payback cannot consider this difference. P10-1. the total cash flow from Machine 1 is $59. Only Machine 1 has a payback faster than 5 years and is acceptable. Thereafter.000 5 years. Answers to NPV-based questions in the first ten problems provide detailed analysis of the present value of individual cash flows. Most students will probably employ calculator functionality to facilitate their problem solution in this chapter and throughout the course. $42. The company should accept the project. d. Machine 2 has returns that last 20 years while Machine 1 has only 7 years of returns. it ignores all cash inflows beyond the payback period.000 4 years. since 6 8. Intermediate a. P10-2. 8 months Machine 2: $21. The quicker cash inflows occur.000 70. and b. One weakness of the payback method is that it disregards expected future cash flows as in the case of Project B.00 2.9 years 4 4.000 20. John should accept Project B.000) (6.000) (4.000 10.000 20.800/2.500 4.500) (1.000 20.000 60. Personal finance: Long-term investment decisions.000 40. c. d. b.500 2.000 $100.000 90.000) 1. Project B is preferred over A because the larger cash flows are in the early years of the project. Choosing between two projects with acceptable payback periods LG 2. 3. Based on the minimum payback acceptance criteria of 4 years set by John Shell. Intermediate a. Project A Annual Cumulative Cash Flow Cash Flow $(9.000) (7.500 1. both projects should be accepted.9 years is lower than Project B’s payback of 4.25 years The payback method would select Project A since its payback of 3.000 20.000) 2.000 1. P10-4.000 12. Project A Cash Investment Inflows Balance $10.000 40. since they are mutually exclusive projects.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 P10-3.000 10. payback period LG 4 a.000 30.500) (6.000 30.000) Year 0 1 2 3 4 5 Total Cash Flow Payback Period c.25 years.000 1.300) (1.000/4. However.500 3.000 $(9.000 $(9.000 30.000 0 Year 0 1 2 3 4 5 Year 0 1 2 3 4 5 Both Project A and Project B have payback periods of exactly 4 years.000 3 1.000 $100.000 0 Project B Cash Investment Inflows Balance 40.500 1.800 11. the greater their value.500 2. .800) (4.800) Project B Annual Cumulative Cash Flow Cash Flow $(9. 26 Accept project b.63 Accept. I 14%.63 $24.000 Solve for PV $13. Basic NPV PVn a.26 NPV $13. NPV LG 3.838. I 10%.115.63 NPV PVn Initial investment NPV $26.000 Solve for PV NPV NPV Reject c.61 14%.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 P10-5. I 12%. N 19. I 14%.65 $3. PMT $3.000 Solve for PV $24.246.869. PMT $5.65 $33. positive NPV b.246. PMT $2.000 NPV $838.39 $25.000 20. 10% N 8. PMT $5000 Solve for PV $26.000 $33.26 $10.20 NPV PVn Initial investment NPV $24. positive NPV . N 20.869.130.115. I Solve for PV NPV NPV NPV Accept $33.65 $30. 12% N 8.20 Accept.838.000 NPV $2. Basic a.674. PMT $5.115 P10-6.674.000 $5. Initial investment N 20.39 $19.20 $24.246.674. NPV for varying cost of capital LG 3.115.000 NPV $3. CF9 $70.000 Solve for PV $1.000. 14% N 8.32 NPV PVn Initial investment NPV $23. CF10 $11.000.000 Solve for PV $20.000.000.135. PMT $4.066.46 NPV $20. Intermediate Project A N 10.000.000 NPV $116.066.000.54 Reject Project B—PV of Cash Inflows CF0 -$500. CF5 $30. CF1 $0. CF2 $0.000.000. Set I 14% Solve for NPV -$83. NPV—independent projects LG 3.24 Reject Project D N 8.000 NPV $5.32 $24.000.939 $950.864. CF4 $160.000.000. I 14%.194.000.864.000.000 NPV -$805. CF6 $200. CF2 $120. CF3 $0. I 14%.963.000.000. CF2 $19.000. CF6 $0.000. CF8 $13. CF7 $50. CF8 $60.668.000 Set I 14% Solve for NPV $9. I 14%.887. CF3 $18.46 $26.93 Accept Project C—PV of Cash Inflows CF0 -$170.000. negative NPV P10-7. CF4 $20.000.000. PMT $5. PMT $230. CF5 $16.63 Accept . CF1 $20. CF1 $100. CF5 $180.939 NPV PVn Initial investment NPV $1. CF3 $140.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 c. CF4 $17.000.68 Reject. CF7 $14.000.194. CF6 $15. CF9 $12.000 Set I 14% Solve for NPV $53.000 Solve for PV $23.939 Accept Project E—PV of Cash Inflows CF0 -$80. 74 The immediate payment of $1. PV $1. CF1 $18.000. PMT $4.500. N 8 .000 NPV –$320.679. P10-9. PV -$13.000 Solve for I 8.46 $13.632. N 5.000.86% 8.000 is not preferred because it has a higher present value than does the annuity.86% is the maximum required return that the firm could have for the project to be acceptable. I 9%. b.515.228. Press A CF0 -$85.69 c.515. and b. Present valueAnnuity Due PVordinary annuity (1 discount rate) $1. No.500. I 9%.46 NPV PV Initial investment NPV $12.74 (1.000.000 Solve for PV $1. NPV LG 3.638.497.292 Calculator solution: $1. F1 Set I 15% Solve for NPV -$4.000 lump-sum option. Intermediate a.54 Reject this project due to its negative NPV.000 Solve for PV $12.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 P10-8. Since the firm’s required return is 10% the cost of capital is greater than the expected return and the project is rejected.500. the cash flows from the project will not influence the decision on how to fund the project. Challenge a. PMT $385. NPV and maximum return LG 3.09) $1.632.497. N 5. d.000 Solve for PMT $385. 4. NPV—mutually exclusive projects LG 3. I 10%.679.500. P10-10.292 Changing the annuity to a beginning-of-the-period annuity due would cause Simes Innovations to prefer to make a $1. N 4.21 Reject b.000 one-time payment because the present value of the annuity due is greater than the $1. PMT $4. The investment and financing decisions are separate. Challenge a. 584.000 Annual incremental benefit $ 20.000. CF3 $20.000 Set I 15% Solve for NPV $15. CF2 CF5 $20. Profitability Indexes Profitability Index Press A: $80.000.000 Time frame (years) 40 Opportunity cost 6.000 0.89 Accept c.584.000 $60.21 $20.000. Press C CF0 -$130.000 F1 40 Set I 6% Solve for NPV $200.000. . CF1 $50. CF7 $40. P10-11.000 CF1 20. CF8 $50. then Press A (which is unacceptable).34 Accept $14. d.228. Ranking—using NPV as criterion Rank 1 2 3 Press C B A NPV $15. CF1 $12.000.000. Personal finance: Long-term investment decisions.12 Investment e.89 2.000. CF6 $25.000.04 1. then Press B. The profitability index measure indicates that Press C is the best.043. CF6 $30. This is the same ranking as was generated by the NPV rule.926 The financial benefits outweigh the cost of the MBA program. CF4 $18. NPV method LG 3 Key information: Cost of MBA program $100. CF4 CF5 $20.000. CF2 $30.000 $130.95 1.000.070 Present Value Cash Inflows $85.771 Press B: $62.0% Calculator Worksheet Keystrokes: CF0 100.000.000.34 4.043.588 Press C: $145. CF3 $16.000.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 Press B CF0 -$60.000.000 Set I 15% Solve for NPV $2. is preferred. b.000) 3.500.000 19.82 Accept Project B $40.09) $15.000 b. Intermediate a.000 13.09 $166.000 $240. it has the lowest payback period and the highest NPV. 3.000 10.000 $5. Project C has the highest NPV.000 19.000 0. P10-13.667 $15.53 Reject Project C $40. Annual EVA c.000 16. high early-year cash inflows.000 13. At a cost of 16%.500. NPV and EVA give exactly the same answer.000 ($10. . Payback and NPV LG 2.667 In this case.000 13. Overall EVA $240. Intermediate a.08 years 3.000 $322.000 $13.000 $2. Project A B C 3 2 Payback Period $40.000 7. Worksheet keystrokes Year 0 1 2 3 4 5 Solve for NPV Project A $40.000 13.000 x 0.000 13. with the shortest payback period.17 Accept Project C is preferred using the NPV as a decision criterion.000 0. c. NPV and EVA LG 3.000 16.63 years 2.454.000 – ($2.000 7.09 $166.38 years Project C.000 ($5.000 10.000 13.000 $16.565. NPV $2.000 13.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 P10-12.000) $13. Because of Project C ’s cash flow characteristics. CF1 $7500.000 (1 IRR)2 $150.000. CF1 $7500. CF0 $20.000 CF0 -$500. CF2 $25. IRR—Mutually exclusive projects LG 4. Project A CF0 $90. CF2 $7500.000 (1 IRR)5 $190.000. and b. CF4 $35.000. CF3 $30.000 . Intermediate IRR is found by solving: $0 n t 1 CFt (1 IRR)t initial investment Most financial calculators have an ―IRR‖ key. Project Y $0 $140.000 (1 IRR)3 $70.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 P10-14. P10-15.000. CF3 $150. CF1 $150. CF2 $100.000 (1 IRR)3 $190.16%).000. CF1 $100. CF5 $7500 [or. since IRR cost of capital. CF2 $150.000 Solve for IRR 15.000.000 (1 IRR)4 $250. CF4 $7500. allowing easy computation of the internal rate of return.000. CF1 $150.000 (1 IRR)4 $50. accept.000 (1 IRR)1 $120. Project C CF0 $20. CF3 $150.000.000. CF1 $120. F1 4] Solve for IRR 8. CF3 $7500. CF4 $150. The numerical inputs are described below for each project.16% The firm’s maximum cost of capital for project acceptability would be 21% (21.000 Solve for IRR 21. CF0 $490. Project B CF0 $490. the project would be acceptable.62%.000.000.000.000 (1 IRR)2 $95. CF1 $20.43% If the firm’s cost of capital is below 17%. CF4 CF5 $250.000.000 [or. CF2 $120.000 $40. CF5 Solve for IRR 17.000.000.67.000. CF4 $60.41%. Intermediate a.000 (1 IRR)5 $500. Project D CF0 $240.62% The firm’s maximum cost of capital for project acceptability would be 8.000.41% The firm’s maximum cost of capital for project acceptability would be 25. F1 5] Solve for IRR 25. CF3 $80.000 $325. Project X $0 $100. IRR—Mutually exclusive projects LG 4.000.000 (1 IRR)1 $120.000.000.000. N 10. $70. PV $18. Challenge a.29%.250. and cash inflows LG 4.000 Solve for PV $19. PMT $10.250 NPV $1.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 CF0 $325. PV $61.000 Solve for IRR 17.000.223. NPV and IRR LG 3.68 b.450.0% The IRR cost of capital. PV $25. reject the project.450 Solve for PMT $12.244. CF4 CF5 $50. PV -$61.01% c. N 7. with the higher IRR.000 Solve for N 18.000. CF3 $95.450.5% Decision: Reject investment opportunity P10-17. IRR.000. Intermediate a. PMT $10.40% Required rate of return: 7.473. Personal Finance: Long-term investment decisions. I 15%. CF2 $120.000.000 Solve for I 12. .000 P10-16. PMT $6. accept.04 P10-18.68 NPV PV Initial investment NPV $19. 4.000 Solve for IRR 6. Project Y. I 10%. PMT $4. CF1 $140. although both are acceptable. PV $61. investment life. I 15%. N 10.472 $18.000. since IRR cost of capital. Intermediate IRR is the rate of return at which NPV equals zero Computer inputs and output: N 5.000 Solve for I 10. is preferred. c. PMT $4. The project should be accepted since the NPV 0 and the IRR the cost of capital. IRR method LG 4. b. N 7.23 years The project would have to run a little over 8 more years to make the project acceptable with the 15% cost of capital. c. 000.7%.117.78 Accept NPVC Key strokes CF0 $80.117.000. CF1 $100. Rank 1 2 3 4 c.000 Set I 15% NPVA $4. CF2 Set I 15% Solve for NPV $6.50 Or. CF2 Set I 15% Solve for NPV $1. CF1 $35.000 NPVD Key strokes CF0 $180.000 $20. Press C D B A NPV $7.51% Since the lowest IRR is 9.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 P10-19.335.50 $80.78 4335.000.99 1.99 Accept b.000.50 (N 3. with rankings LG 3.70% 15.000. NPVA $45.63% 19. Note: Since Project A was the only rejected project from the four projects. I 15.000. 4. .000. all of the projects would be acceptable if the cost of capital was 9.665.000 Using the calculator. CF3 $60. CF2 $20. Intermediate a. CF1 Set I 15% Solve for NPV $7.000.02 Accept $50. CF3 $50. CF3 $60. using NPV keystrokes CF0 $50.000.898.02 6.50 Reject NPVB Key strokes CF0 $100. CF1 $20. CF3 $20. all that was needed to find the minimum acceptable cost of capital was to find the IRR of A.44% 17.335. the IRRs of the projects are: Project A B C D IRR 9.000) $50. PMT $20.000 NPVA -$4. NPV.088.000.000.088.7%.000. CF2 $40.898. 000 15.000 NPVB $75.34 NPVB: CF0 $150.000 2 years Year 0 1 2 3 4 5 6 Payback A Payback B Year 0 1 2 3 4 Project B Cash Investment Inflows Balance $75. NPVA ($45.000 $150.000 $150. conflicting rankings LG 2.000 45.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 P10-20. 4: Intermediate a.112. All techniques.000 30. At a discount rate of zero.000 30.000.36 Accept d. CF1 $75.000 $270.000 30.000 c.000 15. CF1 $45. CF3 $120.886. CF2 Set I 9% Solve for NPV $51.71% 6 6 $60.000 6) .000.000 30.000 years 2.000 $60. NPVA: CF0 $150.000 $45.91% IRRB: CF0 $150.000 $120.000 45.000 105.000 60.000 75.000 . CF1 $75. CF3 $120.000 $150. IRRA: CF0 $150.000 3.000 $105.000 0 $150.000 45.000 15.000 30.000. 3.000 b.000.000. CF1 $45. F1 Solve for IRR 19.000. Project A Cash Investment Inflows Balance $45.$150.000.000 60.33 years 3 years 4 months 2 years 6 months $15. dollars have the same value through time and all that is needed is a summation of the cash flows across time.000.000 45.000 $120. CF2 Solve for IRR 22.000.000 45.000. F1 Set I 9% Solve for NPVA $51.000 $60.5 years $30.000 $150. 4.000 3 ($20. Payback period Balance after 3 years: $95. Intermediate a. CF2 $35. CF1 $25. CF2 $25. IRR.000 Set I 12% Solve for NPV $9. CF1 $20. 4. Challenge a. and NPV profiles LG 3. P10-22. CF3 $30.000 (1 IRR) 4 $40.000 $25.000.000.000 CF5 $40.000 $20. accept IRR 15%. The reinvestment rate assumption of A is 9%. Rank NPV 1 2 Project A B Payback 2 1 IRR 2 1 The project that should be selected is A. the project’s IRR. CF1 $20.237. NPV computation CF0 $95. CF5 $55. Project A CF0 $130. P10-21.000 CF0 $95.000.60 c. since NPV 0.000 $20. CF3 $45.36% $25.000.57 years b. On a practical level Project B may be selected due to management’s preference for making decisions based on percentage returns and their desire to receive a return of cash quickly.000. the firm’s cost of capital.000.000 $35. and b. The conflict between NPV and IRR is due partially to the reinvestment rate assumption.000) 3.000 Solve for IRR 15.71%.000 Set I 12% NPVA $15.000 (1 IRR) 5 $95.000.000 CF4 $50.000. Solve for IRRA 16.000 d. CF2 CF5 $40. 3.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 e.000. NPV $9. 5.06% . since IRR 12% cost of capital.71 Based on the NPV the project is acceptable since the NPV is greater than zero. and IRR LG 2.000. NPV.080. CF4 $35.000.000 (1 IRR)3 $35. Payback. CF4 $35.000 $30.080. The assumed reinvestment rate of Project B is 22. CF3 $30. $0 $20. NPV.000.000 (1 IRR)1 $25.000 (1 IRR)2 $30. accept The project should be implemented since it meets the decision criteria for both NPV and IRR. CAPITAL BUDGETING PROBLEMS: CHAPTER 10 Based on the IRR the project is acceptable since the IRR of 16% is greater than the 12% cost of capital. . Project A is better. The net present value profile indicates that there are conflicting rankings at a discount rate less than the intersection point of the two profiles (approximately 15%).75% Based on the IRR the project is acceptable since the IRR of 17.75% is greater than the 12% cost of capital. At discount rates above approximately 15%. below approximately 15%. whereas Project B has a decreasing cash flow from Year 1 through Year 5.000 Set I 12% NPVB $9.000.238 — 0 — B $35. c. Based on Thomas Company’s 12% cost of capital. The conflict in rankings is caused by the relative cash flow pattern of the two projects. Project A has an increasing cash flow from Year 1 through Year 5. Data for NPV Profiles NPV Discount Rate 0% 12% 15% 16% 18% A $80.000.000. e.161 $ 4. The IRR method reinvests Project B’s larger early cash flows at the higher IRR rate.79 Based on the NPV the project is acceptable since the NPV is greater than zero. Project A should be chosen.161. Solve for IRRB 17. not the 12% cost of capital.177 — 0 d. CF2 $35.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 Project B CF0 $85.000 $15. .000.000 $9. Cash flows moving in opposite directions often cause conflicting rankings. Project B is preferable. CF3 $30.000 CF4 $10. CF5 $5. CF1 $40. 000 $20.344. CF1 $20. F1 5 Solve for IRRB 17.02 c. F1 5 Set I 13% Solve for NPVC $4. All techniques—decision among mutually exclusive investments LG 2. 6.000.2 years $ 10.000 Project B: $100. NPV Project A CF0 $60.500 3.500 3 years 3. F1 5 Set I 13% Solve for NPVA $10. 3.59% .000 $31.000.000.000 3 years $10. CF1 $32.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 P10-23.500.793 17.86% Project B CF0 $100. CF1 $31. CF1 $20.33% C $ 32.4 years $ 4.500 3. F1 5 Solve for IRRC 14. CF1 $32.792.78 Project C CF0 $110.000.63 Project B CF0 $100.34% Project C CF0 $110. Payback* b. CF1 $31. F1 5 Set I 13% Solve for NPVB $10.000.000 $32. Challenge A $20.59% Cash inflows (years 1 5) a.000.4 years b.310. NPV* c.500. 5.500. IRR* * Supporting calculations shown below: a. Payback Period: Project A: $60.500.000. IRR Project A CF0 $60.500 Project C: $110.000. F1 5 Solve for IRRA 19.310 14.2 years 3.86% Project B $ 31. 4.345 19. depending on the discount rate.15 more to the value of the firm than does adopting A. Challenge a.000 $10.500 4.310 0 — — The difference in the magnitude of the cash flow for each project causes the NPV to compare favorably or unfavorably. 5.793 — 0 — C $52.000) 3 years ($20.67 years . P10-24. 3. Project A Payback period Year 1 Year 2 Year 3 Year 4 Initial investment Payback Payback $60. 6.000 30. Data for NPV Profiles NPV Discount Rate 0% 13% 15% 17% 20% A $40. financial theorists would argue that B is superior since it has the highest NPV.000 $20.000 $80. All techniques with NPV profile—mutually exclusive projects LG 2.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 d.000 3.340 — — 0 B $57. e. Even though A ranks higher in Payback and IRR. 4. Adopting B adds $448.500 10. 61% Project B CF0 $50.000 $15.000.000.000. CF1 $15.000. F1 5 Set I 13% Solve for NPVB $2. CF1 $15. Project A CF0 $80. Project A CF0 $80.000. d.000. . CF1 $15. CF3 CF5 $35.000. F1 5 Solve for IRRB 15.68 Project B CF0 $50.000 3.47 c.000. CF2 $20.24% $25. CF1 $15. CF3 CF5 $35. CF2 $20.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 Project B Payback period $50.758.000.000.000.000 Set I 13% Solve for NPVA $3.000.000. CF4 $30. b. CF4 $30.000 Solve for IRRA 14.000.659.33 years $25. First the project does not have an initial cash outflow.000 2. CF4 $343.43 Set I 20%. Both projects are acceptable. at a higher 15% discount rate the NPV is positive and the project would be accepted. Solve for NPV $0.755 — 0 Intersection—approximately 14% If cost of capital is above 14%. the rates are very close.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 Data for NPV Profiles NPV Discount Rate A 0% 13% 14. and equivalent IRRs that are greater than the cost of capital. so the payback is immediate. so the project would be rejected.000. Basic a.43 Set I 10%. For instance. After 2 years. there are cash outflows in later years. . Although Project B has a slightly higher IRR.000 $3.00 Set I 15%.00 Set I 5%. Solve for NPV $7. conflicting rankings occur. However.655 0 — B $25.592. the NPV is negative. the project’s outflows are greater than its inflows. It has an inflow.51 There are multiple IRRs because there are several discount rates at which the NPV is zero.6% 15. Solve for NPV $0.68 Set I 30%. The calculator solution is 13.2% $45. It is best simply to use NPV in a case where there are multiple IRRs due to the changing signs of the cash flows.000. CF1 920. Solve for NPV $6.200 b. Since Project A has a higher NPV. CF2 $1. CF0 $200. Both have similar payback periods. at 5%. e. Solve for NPV $15.87%.205. The oscillating cash flows (positive-negative-positive-negative-positive) make it difficult to even think about how the payback period should be defined. CF3 Set I 0%. 35%. Solve for NPV $0.00 Set I c.000. P10-25. $1. However. e. d. accept Project A. Solve for NPV $39. Solve for NPV $0.00 Set I 25%. Integrative—Multiple IRRs LG 6.200. positive NPVs. It would be difficult to use the IRR approach to answer this question because it is not clear which IRR should be compared to each cost of capital. but that reverses in year 3. The stock price would almost surely decline in the immediate future.34 Solve for IRR 52. Calvert Group (and others) might sell Gap shares and thereby decrease shareholder wealth.360. Project Plant Expansion Product Introduction c. CF2 $2. 6. CF4 $2. In the long run.000 1. the firm’s shareholders would be better off if the firm pursued that project. and we are again reminded that it’s not merely shareholder wealth maximization we’re after—but maximizing shareholder wealth subject to ethical constraints.000. NPV 1 2 Rank IRR 2 1 PI 2 1 The NPV is higher for the plant expansion.411. if Gap was unwilling to renegotiate worker conditions. CF4 $425.360. CF3 $2. Solve for NPV $1.000. d.500.000.500. CF3 $2. Gap may be able to attract and retain better employees (as does Chick-fil-A.500. interestingly enough.000. CF2 $2.360. In fact. CF2 $350.70% CF1 1.411. CF3 Set I 20%.000. but both the IRR and the PI are higher for the product introduction project.000. Solve for NPV $873. by being closed on Sundays).34 (This is the PV of the cash inflows) PI $873.CAPITAL BUDGETING PROBLEMS: CHAPTER 10 P10-26. CF3 $375. 5.14 Solve for IRR 43.000.000 1. Solve for NPV $373.75 b. The NPV recognizes that it is better to accept a lower return on a larger project here.000.844.844.000 $425. new human rights and environmentally conscious customers. This long-run effect is not assured.500.000. Plant Expansion CF0 $3. The rankings do not agree because the plant expansion has a much larger scale.000.000 Set I 20%. Because the NPV of the plant expansion project is higher.000 Set I 20%.000 Set I 20%.33% CF1 250. as cash expenses rise relative to cash revenues.500. CF4 $375.500.844. Ethics problem LG 1. even though it has a lower rate of return. CF2 $350. The IRR and PI methods simply measure the rate of return on the project and not its scale (and therefore not how much money in total the firm makes from each project).55 Product Introduction CF0 $500. and new investor demand from the burgeoning socially responsible investing mutual funds.14 $3.750. P10-27.000. Intermediate a. .000.000. Integrative—Conflicting Rankings LG 3.911. Solve for NPV $5. CF1 1.34 $500.750. CF1 250.000.14 (This is the PV of the cash inflows) PI $5. Intermediate Expenses are almost sure to increase for Gap.000. CF4 $2. 4.000.