HOMEWORK 11

11-6 Your division is considering two projects with the following cash flows (in millions):

a. What are the projects’ NPVs assuming the WACC is 5%? 10%? 15%?
n
CFt
NPV = ∑
t =0 ( 1+r )t
NPVA NPVB
5% $3.52 $2.87
10% $0.58 $1.04
15% -$1.91 -$0.55

b. What are the projects’ IRRs at each of these WACCs?

n
CFt
∑( t = 0
t =0 1+ IRR )
IRRA = 11.10%
IRRB = 13.18%
c. If the WACC was 5% and A and B were mutually exclusive, which project would you choose? What if
the WACC was 10%? 15%? (Hint: The crossover rate is 7.81%.)
When WACC = 5%, the project A should be choose
When WACC = 10%, the project B should be choose
If WACC is 15%, none of project A & B are profitable because IRR < WACC

11-7 CAPITAL BUDGETING CRITERIA A firm with a 14% WACC is evaluating two projects for this
year’s capital budget. After-tax cash flows, including depreciation, are as follows:

a. Calculate NPV, IRR, MIRR, payback, and discounted payback for each project.
Project M Project N
NPV $4,330.81 $6,126.27
IRR 19.86% 16.8%
MIRR 17.12% 15.51%
Payback 3 years 3.21 years
Discounted
4.17 years 4.58 years
payback
 b. Assuming the projects are independent, which one(s) would you recommend?
If projects are mutually exclusive, then both the projects could be accepted.
In both case, NPV is positive, IRR and MIRR is greater than the required rate of return, Payback period
and discounted payback period are lesser than the project life.
c. If the projects are mutually exclusive, which would you recommend?
Though IRR & MIRR is lesser, payback and discounted payback periods are more than project N,
considering NPV project N should be chosen, since it is higher for project N. NPV is considered as
inherent reinvestment assumption.
d. Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV
and IRR?
The conflict between NPV and IRR is because the size of the investment and cashflows are different even
thought the timing is same.

11-10 CAPITAL BUDGETING CRITERIA: MUTUALLY EXCLUSIVE PROJECTS A firm with a

WACC of 10% is considering the following mutually exclusive projects:

Which project would you recommend? Explain.

n
CFt $ 75 $ 75 $ 190 $ 190
NPV 1 = ∑ = -$200 + + + + = $246.1
t =0 ( 1+r )t ( 1+ 10 % ) ( 1+10 % ) ( 1+10 % ) ( 1+10 % )4
1 2 3

n
CFt $ 250 $ 250 $ 1 25 $ 1 25
NPV 1 = ∑ t = -$650 +
+ + + = $40.8
t =0 ( 1+r ) ( 1+ 10 % ) ( 1+10 % ) ( 1+10 % ) ( 1+10 % )4
1 2 3

Project 1 should be accepted because its NPV is higher.

11-12 IRR AND NPV A company is analyzing two mutually exclusive projects, S and L, with the following
cash flows:

The company’s WACC is 8.5%. What is the IRR of the better project? (Hint: The better project may or
may not be the one with the higher IRR.)
n
CFt $ 870 $ 250 $ 25 $ 25
NPV S = ∑ t = -$1000 +
+ + + = $51.8
t =0 ( 1+r ) ( 1+ 8.5 % ) (1+ 8.5 % ) ( 1+8.5 % ) ( 1+8.5 % )4
1 2 3

n
CFt $0 $ 250 $ 400 $ 845
NPV L = ∑ t = -$1000 +
+ + + = $135.2
t =0 ( 1+r ) ( 1+ 8.5 % ) (1+ 8.5 % ) ( 1+8.5 % ) ( 1+8.5 % )4
1 2 3

Therefore, the better project is project L.

$ 870 $ 250 $ 25 $ 25
-$1000 + + + + = 0 , so the IRR of the project L is 12.7%.
( 1+ IRR ) ( 1+ IRR ) ( 1+ IRR ) (1+ IRR )4
1 2 3

11-13 MIRR A firm is considering two mutually exclusive projects, X and Y, with the following cash flows:
The projects are equally risky, and their WACC is 11%. What is the MIRR of the project that maximizes
shareholder value?
Project X:
3 2
$ 110 ×0.11 + $ 300 × 0.11 +$ 430 ×0.11+$ 700
$1000 = , therefore MIRR is 15.5%
( 1+ MIRR )4
Project Y:
3 2
$ 110 0 ×0.11 + $ 90 × 0.11 + $ 55 ×0.11+ $ 50
$1000 = , therefore MIRR is 9.67%
( 1+ MIRR )4
So project Y maximizes shareholder value.

11-14 CHOOSING MANDATORY PROJECTS ON THE BASIS OF LEAST COST Kim Inc. must install a
new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise, the
highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low
capital costs, respectively). HCC has a high capital cost but relatively low operating costs, while LCC has a
low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown
here. Kim’s WACC is 7%.

a. Which unit would you recommend? Explain.

NPV of HCC=-610000-45000/7.5%*(1-1/1.075^5)=-792064.8206
NPV of LCC=-110000-170000/7.5%*(1-1/1.075^5)=-797800.4333
Since we are examining costs, the unit chosen would be the one that had the lower NPV of costs. Since
HCC's NPV of costs is lower than LCC's, HCC would be chosen.
b. If Kim’s controller wanted to know the IRRs of the two projects, what would you tell him?
IRR cannot be calculated.
c. If the WACC rose to 15%, would this affect your recommendation? Explain your answer and the reason
this result occurred.
NPV of HCC=-610000-45000/15%*(1-1/1.15^5)=-760846.9794
NPV of LCC=-110000-170000/15%*(1-1/1.15^5)=-679866.3667
When the WACC increases to 15%, the NPV of costs are now lower for LCC than HCC.