Finance Sample 2 | EssayIvy.com

HW#6

FIN365 Advanced Financial Management

Spring 2019

Name:__________________

1. Consider the following two mutually exclusive projects: A and B. Both

projects require an annual rate of return of 15%. The cash flows for the two

projects are as below:

Year Project A Project B

0 -600,000 -1,800,000

1 270,000 1,000,000

2 350,000 700,000

3 300,000 900,000

1) Calculate the IRR (using the Excel function, “=IRR”) for each project. Based

on the IRR, which one should be your choice?

Answer:

For computation of IRR

Outflow= Inflow

Outflow= CF

+ CF

(1+r) (1+r)

(1+r)

IRR of Project A=

600,000= 270,000 + 350,000 + 300,000

(1+r) (1+r)

(1+r)

Computing r, we get 24.3%

IRR of Project B=

1,800,000= 1,000,000 + 700,000 + 900,000

(1+r) (1+r)

(1+r)

Computing r, we get 21.5%

Therefore, Project A should be selected.

2) Calculate the NPV for each project, using your calculator (please also use the

Excel function to double check your result). Based on the NPV rule, which

one should you recommend?

Answer:

Project A

Year

Cash flow

PV @

15%

270,000

234,783

350,000

264,650

300,000

197,255

Less: Initial

Investment

600,000

NPV

96,688

Project B

Year

Cash flow

PV @

15%

1,000,000

869,565

700,000

529,301

900,000

591,765

Less: Initial

Investment

1,800,000

NPV

190,631

Therefore, Project B should be selected.

3) Is there a conflict between the two rules? If yes, which project should be

taken?

Answer: Yes there is a conflict between two rules.

· NPV prefers B to A

· IRR prefers A to B

In Case of conflict we choose higher NPV Project, Thus we select B

2. Tom is considering three different investment plans--A, B, and C--that his

broker has offered to him. Each plan requires the same amount of investment

but provides different cash flows as follows:

End of Year A B C

1 $200 0 $500

2 200 0 0

3 200 0 0

4 200 200 500

5 0 200 0

6 0 200 0

7 0 200 0

8 0 200 500

Because Tom only has enough savings for one investment, his broker has

proposed the third alternative to be, according to his expertise, “the best in town.”

However, Tom questions his broker’s recommendation and asks you for help. The

required rate of return for the three investments is the same: 10%. What is Tom’s

best alternative? Why? [Hints: Compare the PV of the future cash flows.]

Answer:

Comparing PV of future cash flow of all the Projects, the Project with highest value

should be selected.

Alternative A

Year

Sum

200

@10%

181.8

165.3

150.3

136.6

634

Alternative B

Year

Sum

200

@10%

136.6

124.2

112.9

102.6

93.3

570

Alternative C

Year

Sum

500

@10%

454.5

341.5

233.3

1029

Since PV of Cash flow is highest for Alternative C, Tom should select Alternative C.

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