A company recently analyzed the project whose cash flows are shown below. However, before the company decided to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm's WACC. The Fed's action did no affect the forecasted cash flows. By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected. The old WACC is 8.00% and the new WACC is 9.75% Year 1 2 Cash -$1,000 $41O $410 $410 flows

A company recently analyzed the project whose cash flows are shown below. However, before the company decided to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm's WACC. The Fed's action did no affect the forecasted cash flows. By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected. The old WACC is 8.00% and the new WACC is 9.75% Year 1 2 Cash -$1,000 $41O $410 $410 flows

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Overall, you should find conflicting recommendations based on the various criteria. Why is this occuring?
investments we make today generate cash flows at different time intervals in the future.This makes the evaluation process complicated.How do you address this issue when ivaluating investment projects
1) What is the company's WACC? 2) Should the company take the projects? Assume that the projects have the same risk as an average project for your firm. 3) If one project is depended on the other in a way that the company can only take both projects, should it take it?
Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky. O If a project's IRR is equal to its WACC, then under all reasonable conditions, the project's IRR must be negative. O If a project's IRR is equal to its WACC, then under all reasonable conditions the project's NPV must be zero. O There is no necessary relationship between a project's IRR, its WACC, and its NPV. O When evaluating mutually exclusive projects, those projects with relatively long lives will tend to have relatively high NPVS when the cost of capital is relatively high. O If a project's IRR is equal to its WACC, then, under all reasonable conditions, the project's NPV must be negative.
he IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR. However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the project’s IRR. Consider the following situation: Green Caterpillar Garden Supplies Inc. is analyzing a project that requires an initial investment of $3,000,000. The project’s expected cash flows are: Year Cash Flow Year 1 $275,000 Year 2 –150,000 Year 3 475,000 Year 4 400,000 Green Caterpillar Garden Supplies Inc.’s WACC is 8%, and the project has the same risk as the firm’s average project. Calculate this project’s modified internal rate of return (MIRR): 15.88% 14.21% 18.39% -20.35% If Green Caterpillar Garden Supplies Inc.’s managers select projects based on the MIRR criterion, they should this independent project.…
4. Modified internal rate of return (MIRR) The IRR evaluation method assumes that cash flows from the project are reinvested at the same rate equal to the IRR However, in reality the reinvested cash flows may not necessarily generate a return equal to the IRR. Thus, the modified IRR approach makes a more reasonable assumption other than the project's IRR Consider the following situation: Cold Goose Metal Works Inc. is analyzing a project that requires an initial investment of $600,000. The project's expected cash flows are: Year Year 1 Year 2 Year 3 Year 4 Cold Goose Metal Works Inc.'s WACC is 7%, and the project has the same risk as the firm's average project. Calculate this project's modified internal rate of return (MIRR): 17.50% 14.00% Cash Flow $350,000 -100,000 450,000 400,000 19.25%
You recently found out that when the market is in recession, ALL assets seem to suffer from some degree of liquidity problems as there are less trades than usual, and thus it is hard to sell an asset without losing some of its fair value. So, you concluded that at least some portion of liquidity risk must be systematic in nature and therefore it must be compensated by the market. To verify this, you cut the market portfolio in half by the illiquidity measure developed by Amihud (2002) [So that you have one relatively liquid portfolio and one relatively illiquid portfolio. Assume that this measure is reliable.] and calculated the market liquidity risk premium as follows: Market liquidity risk premium = Expected return on the illiquid portfolio - Expected return on the liquid portfolio = [E(RIL) - E(RL)] Then you formed 5 portfolios from the entire market based on liquidity (Amihud measure) and estimate the factor loading β (called liquidity beta) of each portfolio using [RIL - RL] as…
A company considering a project with extremely risky cash flows decides to apply a premium to the discount rate used to evaluate the project. The management of the company has set the following limits regarding the use of premia on discount rates: If the CV of the project is less than 1, no premium is added. If the CV of the project is 1 or more, but less than 1.5, the discount rate is multiplied by 1.5 If the CV of the project is 1.5 or more, the discount rate is multiplied by 2. The project under consideration has a CV of 1.5 while the company’s WACC is 10%. What would the discount rate employed to evaluate the project be?
Current Design Co. is considering two mutually exclusive, equally risky, and not repeatable projects, S and L. Their cash flows are shown below. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost. r: 8% Year CFS CFL $149.21 $130.31 $121.42 $101.96 $98.10 0 -$1,200 -$2,800 $700 $600 2 $600 $735 3 $150 $700 4 $110 $1,800
When nominal interest rates have hit the zero lower bound, can central banks affect the interest rates? Select one: OA. Yes: since the zero lower bound applies to nominal rates, not real rates, and it is real rates that are relevant for investment decisions. OB. No: once the zero lower bound is hit, central banks can no longer employ interest rates to stimulate economic activity. OC. Yes, but the mechanism by which central banks manipulate the interest rates that matter for spending must deviate from the banks' traditional method. OD. A and C.
Explain liquidity risk and how it can affect financial institutions, and discuss the framework used to help manage this risk to mitigate against liquidity exposure for these institutions.
Assume a project has normal cash flows. All else equal, which of the following statements is correct? A project's regular payback increases as the WACC declines. OA project's IRR increases as the WACC declines. A project's NPV declines as the WACC declines. 4 A project's discounted payback increases as the WACC declines. O A project's MIRR is unaffected by changes in the WACC. None of the above statement.

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