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Chapter 10 The Basics of Capital Budgeting

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Project classification schemes can be used to indicate how much analysis is required to evaluate a given project, the level of the executive who must approve the project, and the cost of capital that should be used to calculate the project’s NPV. Thus, classification schemes can increase the efficiency of the capital budgeting process. The NPV is obtained by discounting future cash flows, and the discounting process actually compounds the interest rate over time. Thus, an increase in the discount rate has a much greater impact on a cash flow in Year 5 than on a cash flow in Year 1. This question is related to Question 10-2 and the same rationale applies. With regard to the second part of the question, the answer is no; the IRR rankings are constant and independent of the firm’s cost of capital. The NPV and IRR methods both involve compound interest, and the mathematics of discounting requires an assumption about reinvestment rates. The NPV method assumes reinvestment at the cost of capital, while the IRR method assumes reinvestment at the IRR. MIRR is a modified version of IRR that assumes reinvestment at the cost of capital. The statement is true. The NPV and IRR methods result in conflicts only if mutually exclusive projects are being considered since the NPV is positive if and only if the IRR is greater than the cost of capital. If the assumptions were changed so that the firm had mutually exclusive projects, then the IRR and NPV methods could lead to different conclusions. A change in the cost of capital or in the cash flow streams would not lead to conflicts if the projects were independent. Therefore, the IRR method can be used in lieu of the NPV if the projects being considered are independent. Yes, if the cash position of the firm is poor and if it has limited access to additional outside financing it might be better off to choose a machine with a rapid payback. But even here, the relationship between present value and cost would be a better decision tool. a. In general, to maximize values are calculation a long-term the answer is no. The objective of management should be value, and as we point out in subsequent chapters, stock determined by both earnings and growth. The NPV automatically takes this into account, and if the NPV of project exceeds that of a short-term project, the higher Answers and Solutions: 10 - 1

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future growth from the long-term project must be more than enough to compensate for the lower earnings in early years. b. If the same $100 million had been spent on a short-term project--one with a faster payback--reported profits would have been higher for a period of years. This is, of course, another reason why firms sometimes use the payback method. 10-8 Mutually exclusive projects are a set of projects in which only one of the projects can be accepted. For example, the installation of a conveyor-belt system in a warehouse and the purchase of a fleet of forklifts for the same warehouse would be mutually exclusive projects-accepting one implies rejection of the other. When choosing between mutually exclusive projects, managers should rank the projects based on the NPV decision rule. The mutually exclusive project with the highest positive NPV should be chosen. The NPV decision rule properly ranks the projects because it assumes the appropriate reinvestment rate is the cost of capital. Project X should be chosen over Project Y. Since the two projects are mutually exclusive, only one project can be accepted. The decision rule that should be used is NPV. Since Project X has the higher NPV, it should be chosen. The cost of capital used in the NPV analysis appropriately includes risk.

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Answers and Solutions: 10 - 2

714.000 12.000 = 4. Financial Calculator Solution: then solve for IRR = 16%. $5.19 4.000 12.02) (15. since the annual cash flows are the same. CF1-8 = 12000. or 6. and then solve for NPV = $7.809.859 18.000 4 | 12.148 23.626.125/$12.788.566.000 12. Financial Calculator Solution: Input CF0 = -52125.08 7.36 7.640.867.29 9.68) (2.846.38) (23.12)2 × (1.541.486.125.68 The discounted payback period is 6 + $2.00) (41.12 6. Input CF0 = -52125.12) 6 | 12.000 12.12)7 Integrated Case: 10 .882 21.60 Cumulative ($52.11) 2. 11 years.079.000 × 1.80) (8. FV 8 | 12.000 3 7 | 12.000 by 1.000 Discounted @12% Cash Flows ($52.000 × (1.053 16. CF1-8 = 12000.71) (31.000 12.000 3 | 12.486.000 5 | 12.12 seven more times to obtain the discounted cash flows (Column 3 values).125. one can divide $12.000 12.SOLUTIONS TO END-OF-CHAPTER PROBLEMS 10-1 10-2 $52.12 × (1.686 FV Inflows: PV 0 1 12% | | 12.788.12 (the discount rate = 12%) to arrive at CF1 and then continue to divide by 1.68.19 Alternatively.12)5 × (1.676.000 13.428.33 8.000 12.51 years. I = 12. 10-5 MIRR: PV Costs = $52.22 6.57 5.3438.303.42 8.12)6 × (1.440 15. The remainder of the analysis would be the same.000 2 | 12.3 .125) 12.125.844.410.00) 10. and 10-3 10-4 Project K’s discounted payback period is calculated as follows: Period 0 1 2 3 4 5 6 7 8 Annual Cash Flows ($52. so the payback is about 4 years.12)4 × (1.

MIRR: PV Costs = $17. NPV = $18. 10-6 Project A: Using a financial calculator.89%. Change I = 5 to I = 15.89% 147.170. FV 5 | 5.100 × 1. Change I = 10 to I = 5.125 13. NPV = $15.100 4 | 5. NPV = $13.596 Financial Calculator Solution: Obtain the FVA by inputting N 12.100.939. PMT = 0.14)2 × (1.213.528 MIRR = = 8.952. CF1-5 = 5100. I = The MIRR = 147596.897. PV = 0.814 6.596. NPV = $12.4 . Change I = 5 to I = 15. FV and then solving for I = 13. PMT = 12000. NPV = $10.100 2 | 5.14 × (1.838.059.954. can be obtained by inputting N = 8. NPV = $16. and then solve for NPV = $408.628 FV Inflows: PV 0 14% | 1 | 5. enter the following: CF0 CF1 CF2 CF3 = -15000000 = 20000000 = 10000000 = 6000000 I = 10.587.108. PV = -52125. enter the following: CF0 CF1 CF2 CF3 = -15000000 = 5000000 = 10000000 = 20000000 26. and then solve for FV = $147.14)3 Integrated Case: 10 . I = 14. Project B: Using a financial calculator.100 5. Change I = 10 to I = 5.100 3 | 5.300.52. 10-7 Truck: Financial Calculator Solution: Input CF0 = -17100.836.71 ≈ $409 and IRR = 1499% ≈ 15%. I = 10.

47. IRRS = 15.14 × (1.14)2 4 | 7.500.24%.430. The MIRR can be obtained by inputting N = 5.7. 10-8 Using a financial calculator: NPVS = $448.11 ≈ $3. I = 14.430 MIRR = 17. FV inflowsL = $73. PMT = 0. MIRR: PV costsS = $15. and then solve for FV = $49.745.86.112 12. FV = 33712. MIRRS = 14. and MIRRS > MIRRL. I = 14. MIRR: PV Costs = $22.14)4 Pulley: Financial Calculator Solution: Input CF0 = -22430.500 × (1.500 × (1.000. and then solve for NPV = $3. MIRRL = 14. PMT = 0. IRRS > IRRL. and then solving for I = MIRR = 14. PV = 0. The MIRR can be obtained by inputting N = 5.576 FV Inflows: PV 0 14% | 1 | 7.712.19%. PMT = 7500.54% (Accept) 33. IRRL = 14. Thus.67%.100 MIRR = 14.614 17. PV = -22430.37%. NPVL > NPVS.556 8.14)4 22. PV = -17100.500 2 | 7.500 8. I = 14.550 9. PV = 0. PV costsL = $37.14) 3 3 | 7.372. FV inflowsS = $29.318 and IRR = 20%.500 × 1.16. FV = 49576.318. CF1-5 = 7500. NPVL = $607. × (1. and then solving for I = 17.20.576. PMT = 5100.712 Financial Calculator Solution: Obtain the FVA by inputting N = 5.667 49. Integrated Case: 10 .67%. However. NPV favors Project L.747 11.54%.19% (Accept) Financial Calculator Solution: Obtain the FVA by inputting N = 5. and then solve for FV = $33.5 . and hence Project L should be chosen. The scale difference between Projects S and L results in IRR and MIRR selecting S over L. FV 5 | 7.

32 140. see that Project X has the higher NPV.00 448.000 = $1. The PV of costs for the conveyor system is -$556. L has the higher NPV.12)2 3 | 400 × 1.407. Thus.000 × (1. IRRL = 11.37/(1 + MIRRY)4. NPVL = $53.(-$556. The IRRs of the two alternatives are undefined.55.02 and NPVY = $39. Project Y: 0 12% | -1.14.6 .37 1. since MIRRX > MIRRY.717.81 $1. 10-12 Step 1: Determine the PMT: Integrated Case: 10 . Project X should be chosen.717) = $63.12 1.00 125.12)2 3 | 50 × 1. the forklift system is expected to be -$493. and just calculate MIRRX.49%.664.664.94. Thus.310 less costly than the conveyor system.636.49 1.00 56. the cash flow stream must include both cash inflows and outflows. 10-10 Project X: 0 12% | -1.74%. and hence the forklifts should be used.000 13.10% = MIRRY $1.44 1. Alternate step: You could calculate NPVs.00 376.000 1 | 100 × (1.12)3 2 | 100 × (1.000 1 | 1.93 1. NPVX = $58. and then calculate NPV at 10 percent and the IRR of each of the projects: Project S: Project L: NPVS = $39.81/(1 + MIRRX)4. IRRS = 13. b. To calculate an IRR. 10-11 Input the appropriate cash flows into the cash flow register.636. it is the better project.59% = MIRRX 4 | 700.12 4 | 50.000 13.12)3 2 | 300 × (1.000 = $1.407 .74%.404. while the PV of costs for the forklift system is -$493. Since Project IRRL = 11.10-9 a.

68 . 10-14 a. and PMT = -176.61 to obtain I = MIRR = 10. b. Ignoring environmental concerns. .000 176. Year 0 1 2 3 Sales ($20.98. CF1-5 = 350000. input N = 10.000) 60. I = 14.000 = 0.820.98 × 1. I = 12. input N = 10.61.98 2 | 176. IRR = 19. c. and FV = 0 to obtain PMT = $176.000 10.000) Net ($20. PV = -1000.500 22. and FV = 2820.500 Royalties ($5.065.22%.000 1 | PMT • • • 10 | PMT With a financial calculator.93% = MIRR 10 | 176. 379.10)8 × (1. PV = -1000.10)9 1.000) (3. in which case the project should not be undertaken. I = 10.000 39.0 12% | -1. Integrated Case: 10 .000 52.578.31 TV = 2.98 to obtain FV = $2. .000) 75. 10-13 a.93%.500) Marketing ($10. PMT = 0.000 165.000 $1.98 • • • 9 | 176.61 FV of inflows: With a financial calculator.000 Payback period = $20.98 194.500) (1.10 × (1.820. the project should be undertaken because its NPV is positive and its IRR is greater than the firm’s cost of capital.37 417. These outflows could be so large as to cause the project to have a negative NPV.000 CF0 = -1065000.000 21.000) (10.000/$60. Environmental effects could be added by estimating penalties or any other cash outflows that might be imposed on the firm to help return the land to its previous state (if possible). Then input N = 10. NPV = ? NPV = $136. Purchase price Installation Initial outlay $ 900. PV = 0.33 year. Step 2: Calculate the project’s MIRR: 0 10% 1 | | -1.7 .

a.000 10 | PMT • • • 59 | PMT 60 | PMT FV of first 9 months’ rent under old lease: N = 9.000 2 | -2.$20. CF2 = 39000.600 60 | -2. Check: Integrated Case: 10 .600 59 | -2.910.11)2 + $21. payment at end of month. b.000/month.37 greater than the old lease. 0 1% | 1 | -2. Thus. New lease terms: $0/month for 9 months. FV = 0.600 NPV • • • PV cost of new lease: = -$94.910.08 = $4.90%. Cost of capital = 12% annual (1% per month).$89. I = 1.000 PV cost of old lease: PV = -$89.000/(1.08.000 60 | -2. PV = ? 9 | 0 10 | -2. b. I = 1.11)1 + $39. does a businessperson have a social responsibility not to make this service available? 10-15 Facts: 5 years remaining on lease.470. rent = $2. Using a financial calculator. PMT = ? PMT = $470.000/(1.611. The FV of the first 9 months’ rent is equivalent to the PV of the 51-period annuity whose payments represent the incremental rent during months 10-60. ask your students “Does this service encourage cheating?” If yes. CF1 = 60000.000/(1.11)3 . the new lease payment that will make her indifferent is $2. CF0 = 0. $2. 0 1% | 1 | 0 • • • N = 60. and then solve for IRR = 261. FV = 0. 0 1% | 1 | -2. input CF0 = -20000. CF3 = 21000.NPV = $60.80.737.8 . CF1-9 = 0.45 .000 • • • 9 | -2.80.000 2 | -2. I = 1. CF10-60 = -2600. PV = 0. PMT = -2000. To find this value: N = 51. I = 1. Sharon should not accept the new lease because the present value of its cost is $94.80 = $2.000 + $470. However.45. 60 payments left.062.000 = $81.611.05. Finance theory dictates that this investment should be accepted. PMT = -2000.05. PV = -18737.701. FV = ? FV = $18.000 • • • 59 | -2.35.600/month for 51 months.

60 = -2470. the costs are the same. FV = 0.9113.98. I = 1. the PV cost of this lease equals the PV cost of the old lease. multiply by 12: 12(0. @ 10% Project A Project B Period Cash flows Cumulative (A) Cash flows Cumulative Integrated Case: 10 .470. CF0 = 0.9 = 0.9113%.019113) = 22. CF10 .600 600 CF0 = 0. I = 1. To obtain the nominal cost of capital.000 10-60 -2. The payback periods for Projects A and B are calculated as follows: Period (B) 0 1 2 3 4 5 Project A Cash flows ($400) 55 55 55 225 225 Cumulative (A) ($400) (345) (290) (235) (10) 215 Project B Cash flows ($600) 300 300 50 50 50 Cumulative ($600) (300) 0 50 100 150 Project A's payback is 4 + $10/$225 = 4. 10-16 a. CF10-60 = 600. Project B would be preferred to Project A. PV = ? New lease terms: CF0 = 0.000 -2.9 . PMT = -2000. IRR = ? IRR = 1. Except for rounding. while Project B's payback is 2 years.909. Check: Old lease terms: PV = -$71. CF1-9 = -2000.80 60 | -2. Except for rounding differences.9113.80 59 | -2.94%. @ 10% Disc. Period Old Lease New Lease ∆Lease 0 0 0 0 1-9 -2. The discounted payback periods for Projects A and B are calculated as follows: Disc.470.039. CF1 .470.99.038. b. CF1-9 = 0. According to the payback rule. This is the periodic rate.17.80.04 years. NPV = ? NPV = $71. c.0 1% | 1 | 0 • • • 9 | 0 10 | • • • -2. I = 1. N = 60.80 PV cost of new lease: NPV = -$89.000 0 -2. CF10-60 = -2600.

(B) 0 1 2 3 4 5 ($400.27) (79.00) 272.16 ($600.62) 23.55/$139.32 153.00) 50.42 Project A's payback is 4 + $109.45 41.93 37.62/$31.55) 30.00 45.71 = 4.78 years.00) (350. meanwhile Project B's payback is 4 + $7.34) (41.00) (327.55) (263. Project B would be preferred to Project A.15 31.05 ($600.00) (304. Integrated Case: 10 .73 247.57 34.71 ($400.68 139.05 = 4. According to the discounted payback rule.22) (109.245 years.77) (7.10 .

78/(1 + MIRRA )5 MIRRA = 11.11 .004.10)4 3 | 50 × (1. use a financial calculator and enter the following data: Project A CF0 = -400 CF1 = 55 CF2 = 55 CF3 = 55 CF4 = 225 CF5 = 225 I = 10 NPV = $30. Project A is preferred to Project B.c.53 692.78 $400 = $692.30 439.21% Project B CF0 = -600 CF1 = 300 CF2 = 300 CF3 = 50 CF4 = 50 CF5 = 50 IRR = 12. Project 0 10% | -400 A: 1 | 55 2 | 55 × (1. Project B is preferred to Project A.16 Project B CF0 = -600 CF1 = 300 CF2 = 300 CF3 = 50 CF4 = 50 CF5 = 50 I = 10 NPV = $23.004.50 399.03 $600 = $1.10 5 | 50 55. Integrated Case: 10 .61%.10)3 × (1. Project 0 10% | -600 B: 1 | 300 2 | 300 × (1.03/(1 + MIRRA )5 MIRRA = 10. d.10)2 4 | 50 × 1.00 60. use a financial calculator and enter the following: Project A CF0 = -400 CF1 = 55 CF2 = 55 CF3 = 55 CF4 = 225 CF5 = 225 IRR = 12.42 By the NPV criterion.21 80.10)2 4 | 225 × 1.10) × (1.10 5 | 225 247.23 1. Finding the IRR.50 66.10)4 3 3 | 55 × (1.55 73.85%.28% According to the IRR criterion. Finding net present values. e.

12 .16 385.10 × 1. the projects inflows can be evaluated at the IRR and the present value of these inflows must equal the initial investment.91 The total present value of cash outflows is $706. and since the outflow Integrated Case: 10 . but a cash outflow is missing and must be solved for. Therefore.239. Using a financial calculator enter the following: CF0 = 0 CF1 = 7500 Nj = 10 CF1 = 10000 Nj = 10 I = 10.20.11. NPV = $65. the project's NPV can now be solved. it can be entered into a financial calculator. the initial investment for this project is Using a calculator.00 FV in Year 5 @ 10% 295. Project A is the superior project.62.10)4 × (1. 10-18 The MIRR can be solved with a financial calculator by finding the terminal future value of the cash inflows and the initial present value of cash outflows.10)2 × 1.002.According to the MIRR criterion. In this instance. if the terminal future value of the cash inflows is found.00 451.00 1368. Using the financial calculator to solve for the present value of cash outflows: N = 5 I = 14. One of these cash outflows occurs in Year 0 and the remaining value must be the present value of the missing cash outflow in Year 2. NPV = $10. Therefore.11. Cash inflows CF1 = 202 CF3 = 196 CF4 = 350 CF5 = 451 Compounding Rate × (1.75 237. 10-17 Since the IRR is the cost of capital at which the NPV of a project equals zero.91 $65.002. the MIRR is given.14 PV = ? PMT = 0 FV = 1368. along with the number of years the project lasts and the MIRR. to solve for the initial present value of the cash outflows.11 CF1 = 7500 Nj = 10 CF1 = 10000 Nj = 10 I = 9. and solving for the discount rate that equates these two values.98. CF0 = -65002.

the present value of the Year 2 cash outflow is $206.53%. 0 0 90 0 80 0 70 0 60 0 50 0 40 0 30 0 20 0 10 0 P j cA r et o P j cB r et o Cs o ot f Cpa( ) ai l % t 1 0 1 5 2 0 2 5 3 0 -0 10 -0 20 -0 30 5 k 0. Project A has the greater NPV.0 24. specifically $200. NV P () $ 10 . Project A would be selected. choose Project B if k = 18%. the missing cash outflow for Year 2 is $206.0% 10.0 18. IRRA = 18. Thus.41 as compared to Project B’s NPV of $145.0 30. construct a Project difference in the two projects’ cash flows: Year 0 1 2 3 4 5 6 7 IRR∆ = Crossover rate = 14. Project B has an NPV of $63.62.CFB $ 105 (521) (327) (234) 466 466 716 (180) ∆ which is the Integrated Case: 10 .68 which is higher than Project A’s NPV of $2. At k = 12%. Thus. At k = 18%.0%. Therefore.01. To find the crossover rate.for Year 0 is $500. 10-19 a. b.1%.0 c. IRRB = 24. Project ∆ = CFA .0 12.62 ×(1.1 20.1)2 = $250.66.13 . NPVA $890 283 200 0 (49) (138) (238) NPVB $399 179 146 62 41 0 (51) d.93.

Then solve for I = MIRRA = 15. MIRRB = 17. thus. Thus.Projects A and B are mutually exclusive. 7 Integrated Case: 10 . you will see an “Error-Soln” message. Excel can also be used.10%. MIRRB = 20.53 percent IRR is found. However. if the cost of capital is less than the crossover rate the two methods lead to different project selections--a conflict exists. e.12)3 + $600(1.12)1 + $193/(1.14 .05%. TV inflows = $600(1.49%.03%. and FV = 2547.547.22%. MIRRA = 18. Now enter 10 STO IRR/YR and the 14.60. MIRR is that discount rate which forces the TV of $2.60.12)3 + $180/(1. Here is the MIRR for Project A when k = 12%: PV costs = $300 + $387/(1. Using a financial calculator enter the following inputs: N = 7.12)7 = $952. % o e 0 Pn l a A I R R A =0 2% 2 4 . Similarly. Similarly. both the NPV and IRR methods will lead to the same project selection.00. a calculator’s IRR function will not work.12)2 + $100/(1. However.60 in 7 years to equal $952. At k = 18%. PMT = 0. 10-20 a. Because of the sign changes and the size of the cash flows. Now. PV = -952. One could use the trial and error method of entering different discount rates until NPV = $0.12)2 + $850(1. Project ∆ has multiple IRRs. As long as the cost of capital is greater than the crossover rate. an HP can be “tricked” into giving the roots.547. 0 5 1 0 1 5 2 0 k( ) % 2 5 I R R B =6% 1. After you have keyed Project Delta’s cash flows into the cash flow registers of an HP-10B. only one of the projects can be chosen. When a conflict exists the NPV method must be used. Then enter 100 STO IRR/YR to obtain IRR = 456. NV P ( ilos f Dla ) Mi n o o r l l s 3 0 2 4 1 8 1 2 6 Pn la B C soe Rt = 6 7 r s v r a 1.00.12)1 = $2.

Thus. Assuming (1) equal risk among projects. (Millions of Dollars) NPVB = $11. then Plan B should be accepted.156. 10-21 a. c. while use of the IRR method implies the opportunity to reinvest at the IRR.26% 0 -10 5 10 1 5 20 25 k (%) IRR A = 15. we get: NPVA = $14. other criteria such as the IRR must be used to evaluate the projects.893. The exact crossover rate is calculated as 16. the IRR of Project ∆. The exact crossover rate is calculated as 11. IRRA = 15.26%. b. If the firm had invested in all available projects with returns greater than 12 percent. The NPV method implicitly assumes that the opportunity exists to reinvest the cash flows generated by a project at the cost of capital. the cost of capital is the correct reinvestment rate for evaluating a project’s cash flows. which represents the differences between the cash flow streams of the two projects. Yes.7 percent.07 percent. As cash flows come in from these Integrated Case: 10 . At the crossover rate.03%. Thus. IRRB = 22. the firm would take on all available projects with returns greater than its 12 percent cost of capital.486.7% 20 IRR S = 22.03% The crossover rate is somewhere between 11 percent and 12 percent. If the cost of capital is less than the crossover rate. the IRR of Project ∆.15 .808. then Plan A is preferred. the two projects’ NPVs are equal. then its best alternative would be to repay capital. b. and (2) that the cost of capital is a constant and does not vary with the amount of capital raised. Using a financial calculator. if the cost of capital is greater than the crossover rate. The firm will invest in all independent projects with an NPV > $0. the difference between the cash flow streams of the two projects.The crossover rate is approximately 16 percent. NPV 80 60 40 Crossover Rate = 11.

this is their opportunity cost reinvestment rate. reject the project since NPV < $0. 10 k( ) % 0 10 0 20 0 30 0 40 0 50 0 0% 10 50 80 100 200 300 400 410 420 430 450 k NPV ($1.0) 13. and ready access to capital markets.16 . 05 -.0) We can construct the following NPV profile: NV P ( illio so Dll r ) M n f oas 15 .519 1.000. 0 -.213 25.000 500. which is an incorrect assumption.500. The IRR method assumes reinvestment at the internal rate of return itself. since these cash flows are expected to save the firm 10 percent.659 56.projects. 10-22 a. The project’s expected cash flows are as follows (in millions of dollars): Time 0 1 2 Net Cash Flow ($ 2. Integrated Case: 10 . 05 .174) 1.0 (12. costs 10 percent.000.000 1. accept the project because NPV > $0.632 (33.000) (99. Thus.058) b. If k = 10%. the firm will either pay them out to investors.333. Its NPV at k = 10% is equal to -$99.174. 10 . or use them as a substitute for outside capital which. But if k = 20%.000 120.518. given a constant expected future cost of capital.333 1.000.000 87. Its NPV at k = 20% is $500. in this case.

000.) be is Integrated Case: 10 . (Reject the project since MIRR < k.000. FV inflows = $13.c. d.917.355.000 × 1.10 = $14.54%.000.000/(1.000 + $12. Other possible projects with multiple rates of return could nuclear power plants where disposal of radioactive wastes required at the end of the project’s life.000.17 . MIRR = 9.10)2 = $11.300. MIRR @ k = 10%: PV costs = $2.

181.87%.MIRR @ k = 20%: PV costs = $2.000 13.000 + $12.333.000) (20. 10-23 a.000 10.000. MIRR = 22.000 Cumulative ($25.000. In those situations.098.454.000.545.000) (10.269.818. Payback B (cash flows in thousands): Period 0 1 2 3 4 Annual Cash Flows ($25. the NPV method should be used.82 8.000 Cumulative ($25.18 .28 7.000 8.) Looking at the results.600.000) 5. Decisions in which two mutually exclusive projects are involved and differ in scale (size).45 8.20)2 = $10. Discounted payback B (cash flows in thousands): Period 0 1 2 3 4 Annual Cash Flows ($25. this project’s MIRR calculations lead to the same decisions as the NPV calculations.000/$15.08 Cumulative ($25.456.55) (12.000 15. b.000/$10.52 4.20 = $15.000 PaybackB = 1 + $5.000) 20.264.27 Cumulative ($25.00) 18.000) 20.554.000 8.50 years.00) (20.000 20.000 10.660.46 6.333.264.18) 1.739.00) 4.37) 12.000 Discounted @10% Cash Flows ($25. FV inflows = $13. (Accept the project since MIRR > k.000.67 years.000) 5.000.000 Discounted @10% Cash Flows ($25.000) (5.000 6.660.88 Integrated Case: 10 .000.000 = 2.000.000) 5.000 10.80 11.27 = 3. MIRR can conflict with NPV.000 = 1. Payback A (cash flows in thousands): Period 0 1 2 3 4 Annual Cash Flows ($25.000 20.190.00) (6.90 Discounted PaybackA = 3 + $920.09) (920. However.000 19.46 11.010.000 10.000.000 25. Discounted payback A (cash flows in thousands): Period 0 1 2 3 4 Annual Cash Flows ($25.72 13.000 15.000 6.000 PaybackA = 2 + $10.446.37/$13.07 years.000) 5. the MIRR method will not always lead to the same accept/reject decision as the NPV method.000/(1.000 × 1.

27%. consequently. Project B has the higher NPV. IRRB = 36. At a discount rate of 15 percent.CFB (15) 0 7 14 0 $ 0 IRR∆ = Crossover rate = 13.19 . NPVA = $18. Project A has the higher NPV. and FV = 55255000 to solve for I = 21. NPVB = $11. it should be accepted. At a discount rate of 5 percent.554. NPVB = $8.880. Both projects undertaken.243. and solve for NPV = $37.908. With a financial calculator. and solve for NPV = $36.255. Use 3 steps to calculate MIRRB @ k = 10%: Step 1: Calculate the NPV of the uneven cash flow stream.5254% ≈ 13.264. so both projects should be d.813. Use 3 steps to calculate MIRRA @ k = 10%: Step 1: Calculate the NPV of the uneven cash flow stream.53%.15%. c. then enter I = 10. and PMT = 0 to solve for FV = $55.554. At a discount rate of 15 percent. so its FV can then be calculated. so its FV can then be calculated.18/$8.000.964. then enter I = 10. Year 1 2 3 4 Project ∆ = CFA . NPVB = $14. Step 2: Step 3: Integrated Case: 10 .829. NPVA = $8. Calculate the FV of the cash flow stream as follows: Enter N = 4. At a discount rate of 5 percent. e. enter the cash flow stream into the cash flow registers. PV = -37739908.207.880.390.908. PMT = 0.818. have positive NPVs. PV = -25000000. Calculate MIRRA as follows: Enter N = 4. IRRA = 27.93%. g.739. consequently. NPVA = $12. With a financial calculator. enter the cash flow stream into the cash flow registers.071. At a discount rate of 5 percent. it should be accepted. f.Discounted PaybackB = 1 + $6. I = 10.46 = 1.825 years. At a discount rate of 15 percent.739.643.

and FV = 53520000 to solve for I = 20. Integrated Case: 10 .000. if the 2 projects were mutually exclusive. Step 3: According to the MIRR approach. Project A would be chosen because it has the higher MIRR. we don’t need to worry about a conflict between the MIRR and NPV decisions. PV = -25000000.96%. and PMT = 0 to solve for FV = $53. PV = -36554880.20 . I = 10. Note: Because these two projects are equal in size. This is consistent with the NPV approach. Calculate MIRRB as follows: Enter N = 4.520.Step 2: Calculate the FV of the cash flow stream as follows: Enter N = 4. PMT = 0.

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