Reading 6: Discounted Cash Flow Applications-LOS b 习题精选

If two projects are mutually exclusive, the firm should always choose the project with the highest NPV rather than the highest IRR. If two projects are mutually exclusive, the firm may only choose one. It is possible for NPV and IRR to give conflicting decisions for projects of different sizes. Because NPV is a direct measure of the change in shareholder wealth, NPV criteria should be used when NPV and IRR decisions conflict.

When a project has a positive NPV, it will add to shareholder wealth because the project is earning more than the opportunity cost of capital needed to undertake the project. If a firm takes on a zero-NPV project, the firm will earn exactly enough to cover the opportunity cost of capital. The firm will increase in size by taking the project, but shareholder wealth will not change.

The present value of the current lease is $508,766.38, while the present value of the lease being offered is $459,177.59; a savings of 49,589. Alternatively, the present value of the extra $40,000 at the beginning of each of the next 4 years is $129,589 which is $49,589 more than the extra $80,000 added to the payment today.

Focusing on the maximization of earnings does not consider the differences in risk across projects, while focusing on revenues precludes concern for the expenses incurred. Earning a higher return on a small project provides less of a benefit than earning a slightly lower rate of return on a much larger project.

When projects are independent, you can use either the NPV method or IRR method to make the accept or reject decision. Only Project C has an IRR in excess of 11%. Acceptance of Project A reduces the firm’s value by $4,600.

If the IRR exceeds the cost of capital, that merely indicates that the project is acceptable—this is not a problem associated with IRR. Non-normal cash flow patterns such as cash outflows during the project's life can result in multiple IRRs, leaving open the question as to which one is valid. A higher IRR will only be realized if the project’s cash flows can be reinvested at the IRR, and the true profitability of a project also depends on project size, not just IRR.

The IRR method equates an investment’s present value of inflows to its present value of outflows. The IRR by definition is the discount rate that sets the net present value of a project equal to zero. Therefore, the decision rule for independent projects is as follows: if the IRR is above the firm’s cost of capital, the project should be accepted, and if the IRR is below the cost of capital, the project should be rejected.

Because the investment projects are mutually exclusive, only one project can be chosen. The NPV and IRR criteria are giving conflicting project rankings. When decision criteria conflict, always use the NPV criteria because NPV evaluates projects using an appropriate discount rate, the weighted average cost of capital. The IRR may not be a market rate, therefore future cash flows associated with the project may not be capable of earning a rate of return equal to the IRR.

If a project’s IRR exceeds the cost of capital, the project’s NPV will be positive. The only way in which accepting a positive NPV project would reduce firm value is if its selection precludes selection of a project that would have enhanced firm value to a greater extent (i.e., had a higher NPV). IRR and NPV method accuracy do not depend upon project duration or costs.