honeycfa

Which of the following statements about NPV and IRR is least accurate?

A) For independent projects if the IRR is > the cost of capital accept the project.

B) The NPV method assumes that all cash flows are reinvested at the cost of capital.

C) For mutually exclusive projects you should use the IRR to rank and select projects.

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For mutually exclusive projects you should use NPV to rank and select projects.

honeycfa

Tapley Acquisition, Inc., is considering the purchase of Tangent Company. The acquisition would require an initial investment of $190,000, but Tapley's after-tax net cash flows would increase by $30,000 per year and remain at this new level forever. Assume a cost of capital of 15%. Should Tapley buy Tangent?

A) No, because k > IRR.

B) Yes, because the NPV = $10,000.

C) Yes, because the NPV = $30,000.

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This is a perpetuity.

PV = PMT / I = 30,000 / 0.15 = 200,000

200,000 ? 190,000 = 10,000

honeycfa

Which of the following statements about the discounted payback period is least accurate? The discounted payback:

A) frequently ignores terminal values.

B) period is generally shorter than the regular payback.

C) method can give conflicting results with the NPV.

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The discounted payback period calculates the present value of the future cash flows. Because these present values will be less than the actual cash flows it will take a longer time period to recover the original investment amount.

honeycfa

A company is considering the purchase of a copier that costs $5,000. Assume a cost of capital of 10 percent and the following cash flow schedule:

• Year 1: $3,000
• Year 2: $2,000
• Year 3: $2,000

Determine the project's payback period and discounted payback period.

Payback Period

Discounted Payback Period

A) 2.0 years 2.4 years

B) 2.0 years 1.6 years

C) 2.4 years 1.6 years

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Regarding the regular payback period, after 1 year, the amount to recover is $2,000 ($5,000 - $3,000). After the second year, the amount is fully recovered.

The discounted payback period is found by first calculating the present values of each future cash flow. These present values of future cash flows are then used to determine the payback time period.

3,000 / (1 + .10)¹ = 2,727

2,000 / (1 + .10)² = 1,653 

2,000 / (1 + .10)³ = 1,503.

Then:

5,000 - (2,727 + 1,653) = 620

620 / 1,503 = .4.

So, 2 + 0.4 = 2.4.

honeycfa

An analyst has gathered the following data about a company with a 12% cost of capital:

	Project A	Project B
Cost	$15,000	$25,000
Life	5 years	5 years
Cash inflows	$5,000/year	$7,500/year

Projects A and B are mutually exclusive. What should the company do?

A) Reject A, Accept B.

B) Accept A, Reject B.

C) Reject A, Reject B.

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For mutually exclusive projects accept the project with the highest NPV. In this example the NPV for Project A (3,024) is higher than the NPV of Project B (2,036). Therefore accept Project A and reject Project B.

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If the projects are independent, what should the company do?

A) Reject A, Reject B.

B) Accept A, Reject B.

C) Accept A, Accept B.

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Project A: N = 5; PMT = 5,000; FV = 0; I/Y = 12; CPT → PV = 18,024; NPV for Project A = 18,024 ? 15,000 = 3,024.

Project B: N = 5; PMT = 7,500; FV = 0; I/Y = 12; CPT → PV = 27,036; NPV for Project B = 27,036 ? 25,000 = 2,036.

For independent projects the NPV decision rule