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Concept explainers
a.
To determine:
Internal Rate of Return (IRR):
IRR is the rate at which the future cash inflows will be equal to the initial
a.
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Answer to Problem 10QP
Solution:
Compute the IRR.
Explanation of Solution
- The excel spreadsheet is used to calculate the internal
rate of return . - The IRR function is used to compute the internal rate of return.
Hence, internal rate of return is 12%.
b.
To explain: Whether Person X should accept this offer or not on 10% discount rate.
b.
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Answer to Problem 10QP
Solution:
Person X should accept this offer on 10% discount rate.
Explanation of Solution
One should accept this offer because internal rate of return is 12% which is higher than the discount rate of 10%. It means that the current project will fetch profit for the company.
Hence, Person X should accept this project.
c.
To explain: Whether one should accept this offer or not on 20% discount rate.
c.
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Answer to Problem 10QP
Solution:
Person X should not accept this offer on 20% discount rate.
Explanation of Solution
Person X should not accept this offer because internal rate of return is 12% which is lower than the discount rate of 20%. It means that the current project will not be able to earn even what is initially invested in the project.
Hence, Person X should not accept this project.
d.
To determine: NPV at 10% and 20% discount rate.
Net present value refers to the present value of all the future cash flow that is adjusted according to the
d.
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Explanation of Solution
Compute the NPV.
For discount rate of 10%:
Given,
C0 is $9,400.
CF1 is $4,500.
CF2 is $3,100.
CF3 is $2,400.
CF4 is $1,800.
r is 10%.
Solution:
Formula to compute NPV,
Where,
- C0 is initial investment.
- CF1 is
cash inflow in first year. - CF2 is cash inflow in second year.
- CF3 is cash inflow in third year.
- CF4 is cash inflow in fourth year.
- r is discount rate.
Substitute, $9,400 for C0, $4,500 for CF1, $3,100 for CF2, $2,400 for CF3,$1,800 for CF4 and 10% for r.
The NPV for discount rate of 10% is $285.47.
For discount rate of 20%:
Given,
C0 is $9,400.
CF1 is $4,500.
CF2 is $3,100.
CF3 is $2,400.
CF4 is $1,800.
r is 20%.
Formula to compute NPV,
Where,
- C0 is initial investment.
- CF1 is cash inflow in first year.
- CF2 is cash inflow in second year.
- CF3 is cash inflow in third year.
- CF4 is cash inflow in fourth year.
- r is discount rate.
Substitute, $9,400 for C0, $4,500 for CF1, $3,100 for CF2, $2,400 for CF3,$1,800 for CF4 and 20% for r.
The NPV for discount rate of 20% is −$1,240.27.
Hence, NPV for discount rate of 10% and 20% is $285.47 and -$1,240.27 respectively.
e.
To explain: Whether NPV rule is consistent with IRR rule or not.
e.
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Answer to Problem 10QP
Solution:
Yes, NPV rule is consistent with the internal rate of return method.
Explanation of Solution
NPV rule is consistent with IRR because according to both the methods, project with 10% discount rate is accepted and project with 20% discount rate should be discarded. It is because project is giving positive return only when 10% discount rate is used otherwise it is giving negative returns and it is consistent because, only once the signs of the cash flows changes.
Hence, NPV is consistent with the IRR rule.
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Chapter 5 Solutions
Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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