 # Finance Questions

## Question

Project S has a cost of \$10,000 and is expected to produce benefits (cash flows) of \$3,000 per year for 5 years. Project L costs \$25,000 and is expected to produce cash flows of \$7,400 per year for 5 years. Calculate the two projects’ NPVs, IRRs, MIRRs and PIs, assuming the cost of capital is 12%. Which project would be selected, assuming they are mutually exclusive, using each ranking method? Which should actually be selected?

The Perez Company has the opportunity to invest in one of two mutually exclusive machines that will produce a product it will need for the foreseeable future. Machine A costs \$10 million but realizes after-tax inflows of \$4 million per year for 4 years. After 4 years, the machine must be replaced. Machine B costs \$15 million and realizes after-tax inflows of \$3.5 million per year for 8 years, after which it must be replaced. Assume that machine prices are not expected to rise because inflation will be offset by cheaper components used in the machines. The cost of capital is 10%. By how much would the value of the company increase if it accepted the better machine? What is the equivalent annual annuity for each machine?

The Ulmer Uranium Company is deciding whether or not to open a strip mine whose net cost is \$4.4 million. Net cash inflows are expected to be \$27.7 million, all coming at the end of Y1. The land must be returned to its natural state at a cost of \$25 million, payable at the end of Y2.
a. Plot the projects NPV profile.
b. Should the project be accepted if r = 8%? If r = 14%? Explain the reasoning.
c. Can you think of some other capital budgeting situations in which negative cash flows during or at the end of the project’s life might lead to multiple IRRs?
d. What is the project’s MIRR at r = 8%? At r = 14%? Does the MIRR method lead to the same accept-reject decision as the NPV method?

Your division is considering two investment projects, each of which requires an up-front expenditure of \$25 million. You estimate that the cost of capital is 10% and tht the investments will produce the following after-tax cash flows in millions of dollars):
Year Project A Project B
1              5                 20
2             10                10
3             15                 8
4             20                6

a. What is the regular payback period for each of the projects
b. What is the discounted payback period for each of the projects?
c. If the two projects are independent and the cost of capital is 10%, which project or projects should the firm undertake?
d. If the two projects are mutually exclusive and the cost of capital is 5%, which project should the firm undertake?
e. If the two projects are mutually exclusive and the cost of capital is 15%, which project should the firm undertake?
f. What is the crossover rate?
g. If the cost of capital is 10%, what is the modified IRR (MIRR) of each project?

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