Fundamentals of Corporate Finance
11th Edition
ISBN: 9780077861704
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Bradford D Jordan Professor
Publisher: McGraw-Hill Education
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Chapter 10, Problem 12QP
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The NPV of a project involving an initial investment of x0 at time zero and a constantstream of cash flows x > 0 in all subsequent periods, 1, 2, ...,∞, is x/r − x0. Doyou remember how to derive this result from first principles? What if the project isexpected to be discontinued after T > 1 periods?
aa.4
7. The NPV and payback period
What information does the payback period provide?
Suppose you are evaluating a project with the expected future cash inflows shown in the following table. Your boss has asked you to calculate the
project's net present value (NPV). You don't know the project's initial cost, but you do know the project's regular, or conventional, payback period is
2.50 years.
Year
Year 1
Year 2
Year 3
Year 4
If the project's weighted average cost of capital (WACC) is 10%, the project's NPV (rounded to the nearest dollar) is:
O
O
Cash Flow
$325,000
$475,000
$425,000
$475,000
0
0
$351,183
$367,146
Which of the following statements indicate a disadvantage of using the regular payback period (not the discounted payback period) for capital
budgeting decisions? Check all that apply.
$319,257
$303,294
The payback period is calculated using net income instead of cash flows.
The payback period does not take the project's entire life into account.
The payback period does not take the…
Chapter 10 Solutions
Fundamentals of Corporate Finance
Ch. 10.1 - What are the relevant incremental cash flows for...Ch. 10.1 - What is the stand-alone principle?Ch. 10.2 - Prob. 10.2ACQCh. 10.2 - Prob. 10.2BCQCh. 10.2 - Explain why interest paid is not a relevant cash...Ch. 10.3 - What is the definition of project operating cash...Ch. 10.3 - For the shark attractant project, why did we add...Ch. 10.4 - Prob. 10.4ACQCh. 10.4 - How is depreciation calculated for fixed assets...Ch. 10.5 - Prob. 10.5ACQ
Ch. 10.5 - Prob. 10.5BCQCh. 10.6 - Prob. 10.6ACQCh. 10.6 - Under what circumstances do we have to worry about...Ch. 10 - Prob. 10.1CTFCh. 10 - What should NOT be included as an incremental cash...Ch. 10 - Prob. 10.3CTFCh. 10 - An asset costs 24,000 and is classified as...Ch. 10 - Prob. 10.5CTFCh. 10 - Prob. 10.6CTFCh. 10 - Opportunity Cost [LO1] In the context of capital...Ch. 10 - Depreciation [LO1] Given the choice, would a firm...Ch. 10 - Net Working Capital [LO1] In our capital budgeting...Ch. 10 - Stand-Alone Principle [LO1] Suppose a financial...Ch. 10 - Prob. 5CRCTCh. 10 - Cash Flow and Depreciation [LOI] When evaluating...Ch. 10 - Capital Budgeting Considerations [LOI] A major...Ch. 10 - Prob. 8CRCTCh. 10 - Prob. 9CRCTCh. 10 - Prob. 10CRCTCh. 10 - Relevant Cash Flows [LO1] Parker Slone, Inc., is...Ch. 10 - Prob. 2QPCh. 10 - Calculating Projected Net Income [LO1] A proposed...Ch. 10 - Calculating OCF [LO1] Consider the following...Ch. 10 - OCF from Several Approaches [LO1] A proposed new...Ch. 10 - Calculating Depreciation [LO1] A piece of newly...Ch. 10 - Calculating Salvage Value [LO1] Consider an asset...Ch. 10 - Calculating Salvage Value [LO1] An asset used in a...Ch. 10 - Calculating Project OCF [LO1] Quad Enterprises is...Ch. 10 - Calculating Project NPV [LO1] In the previous...Ch. 10 - Prob. 11QPCh. 10 - NPV and Modified ACRS [LO1] In the previous...Ch. 10 - Project Evaluation [LO1] Dog Up! Franks is looking...Ch. 10 - Project Evaluation [LO1] Your firm is...Ch. 10 - Prob. 15QPCh. 10 - Calculating EAC [LO4] A five-year project has an...Ch. 10 - Calculating EAC [LO4] You are evaluating two...Ch. 10 - Calculating a Bid Price [LO3] Romo Enterprises...Ch. 10 - Cost-Cutting Proposals [LO2] Warmack Machine Shop...Ch. 10 - Comparing Mutually Exclusive Projects [LO1] Lang...Ch. 10 - Prob. 21QPCh. 10 - Prob. 22QPCh. 10 - Prob. 23QPCh. 10 - Comparing Mutually Exclusive Projects [LO4]...Ch. 10 - Equivalent Annual Cost [LO4] Compact fluorescent...Ch. 10 - Break-Even Cost [LO2] The previous problem...Ch. 10 - Break-Even Replacement [LO2] The previous two...Ch. 10 - Issues in Capital Budgeting [LO1] The debate...Ch. 10 - Replacement Decisions [LO2] Your small remodeling...Ch. 10 - Replacement Decisions [LO2] In the previous...Ch. 10 - Calculating Project NPV [LO1] You have been hired...Ch. 10 - Prob. 32QPCh. 10 - Calculating Required Savings [LO2] A proposed...Ch. 10 - Prob. 34QPCh. 10 - Calculating a Bid Price [LO3] Your company has...Ch. 10 - Replacement Decisions [LO2] Suppose we are...Ch. 10 - Conch Republic Electronics, Part 1 Conch Republic...Ch. 10 - Conch Republic Electronics, Part 1 Conch Republic...Ch. 10 - Conch Republic Electronics, Part 1 Conch Republic...Ch. 10 - Conch Republic Electronics, Part 1 Conch Republic...
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- Net Present Value You are evaluating two projects, Project A and Project B . Project A has a short period of future cash flows, while Project B has relatively long future cash flows. Which project will be more sensitive to changes in the required return? Why?arrow_forward1] Payback and Internal Rate of Return: A project has perpetual cash flows of C per period, a cost of I, and a required return of r. What is the relationship between the project’s payback and its IRR? What implications does your answer have for long-lived projects with relatively constant cash flows? 2] WHAT ARE THE PROBLEMS WITH IRR APPROACH TO CAPITAL BUDGETING? 3] COMPARE IRR WITH MIRR METHOD.arrow_forward18. In a situation such as Acron's, where a one-time cost is followed by a sequence of cash flows, the internal rate of return (IRR) is the discount rate that makes the NPV equal to 0. The idea is that if the discount rate is greater than the IRR, the company will not pursue the project, but if the discount rate is less than the IRR, the project is financially attractive. a. Use Excel's Goal Seek tool to find the IRR for the Acron model. b. Excel also has an IRR function. Look it up in online help to see how it works, and then use it on Acron's model. Of course, you should get the same IRR as in part a. c. Verify that the NPV is negative when the discount rate is slightly greater than the IRR, and that it is positive when the discount rate is slightly less thanarrow_forward
- 7. The NPV and payback period What information does the payback period provide? Suppose you are evaluating a project with the expected future cash inflows shown in the following table. Your boss has asked you to calculate the project’s net present value (NPV). You don’t know the project’s initial cost, but you do know the project’s regular, or conventional, payback period is 2.50 years. Year Cash Flow Year 1 $375,000 Year 2 $475,000 Year 3 $500,000 Year 4 $400,000 If the project’s weighted average cost of capital (WACC) is 8%, the project’s NPV (rounded to the nearest dollar) is: $345,386 $328,117 $414,463 $362,655arrow_forwardConsider the following two projects: Cash flows Project A Project B C0�0 −$ 240 −$ 240 C1�1 100 123 C2�2 100 123 C3�3 100 123 C4�4 100 a. If the opportunity cost of capital is 8%, which of these two projects would you accept (A, B, or both)? b. Suppose that you can choose only one of these two projects. Which would you choose? The discount rate is still 8%. c. Which one would you choose if the cost of capital is 16%? d. What is the payback period of each project? e. Is the project with the shortest payback period also the one with the highest NPV? f. What are the internal rates of return on the two projects? g. Does the IRR rule in this case give the same answer as NPV? h. If the opportunity cost of capital is 8%, what is the profitability index for each project? i. Is the project with the highest profitability index also the one with the highest NPV? j. Which measure should you use to choose between the projects?arrow_forwardWhich of the following comes closest to the net present value (NPV) of a project whose initial investment is $5 and which produces two cash flows: the first at the end of year 2 of $3 and the second at the end of year 4 of $7? The required rate of return is 13%? Select one: a. $1.84 b. $0 c. $1.64 d. $2.05 e. $2.26arrow_forward
- 4. Consider the two projects depicted in Table 2: The net present value (NPV) of project A is ________ TABLE 2 Project Year 0 Year 1 Year 2 Year 3 Year 4 Discount Cash Flow Cash Flow Cash Flow Cash Flow. Cash Flow. Rate A. -100. 40. 70 60 0. 0.11 B -80 50 30 30 30 0.11 5 Consider the two projects depicted in Table 2: The net present value (NPV) of project B is ________.arrow_forward7. The NPV and payback period What information does the payback period provide? Suppose you are evaluating a project with the expected future cash inflows shown in the following table. Your boss has asked you to calculate the project’s net present value (NPV). You don’t know the project’s initial cost, but you do know the project’s regular, or conventional, payback period is 2.50 years. Year Cash Flow Year 1 $300,000 Year 2 $450,000 Year 3 $500,000 Year 4 $500,000 If the project’s weighted average cost of capital (WACC) is 8%, the project’s NPV (rounded to the nearest dollar) is: $470,812 $449,412 $513,613 $428,011 Which of the following statements indicate a disadvantage of using the regular payback period (not the discounted payback period) for capital budgeting decisions? Check all that apply. The payback period does not take the time value of money into account. The payback period is calculated using net…arrow_forwardhave any redeeming qualities? LO 4 8.5 Net Present Value Concerning NPV: Describe how NPV is calculated and describe the information this measure provides about a sequence of cash flows. What is the NPV criterion decision rule? a. Why is NPV considered to be a superior method of evaluating the cash flows from a project? Suppose the NPV for a project's cash flows is computed to be $2,500. What does this number represent with respect to the firm's shareholders? b.arrow_forward
- Problem 7: NPV versus IRR. Consider the following two mutually exclusive projects: Year Cash flow Cash flow (X) (Y) O 1 2 3 -9500 5800 4000 4000 PART 7A: The NPV for X is $ Answer: 2083.77 -9500 3500 5000 6000 if the required rate of return is 10%.arrow_forwardConsider projects A and B with the following cash flows: C0 C1 C2 C3 A − $ 27 + $ 16 + $ 16 + $ 16 B − 52 + 27 + 27 + 27 a-1. What is the NPV of each project if the discount rate is 10%? (Do not round intermediate calculations. Round your answers to 2 decimal places.) a-2. Which project has the higher NPV? b-1. What is the profitability index of each project? (Do not round intermediate calculations. Round your answers to 2 decimal places.) b-2. Which project has the higher profitability index? c. Which project is most attractive to a firm that can raise an unlimited amount of funds to pay for its investment projects? d. Which project is most attractive to a firm that is limited in the funds it can raise?arrow_forwardBasic NPV methods tell us that the value of a project today is NPV0. Time value of money issues also lead us to believe that if we choose not to do the project that it will be worth NPV1 one period from now, such that NPV0 > NPV1. Why then do we see some firms choosing to defer taking on a project?arrow_forward
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