CHAPTER 13 - WEIGHING NET PRESENT VALUE AND OTHER CAPITAL BUDGETING CRITERIA

Questions

LG1 1. Is the set of cash flows depicted below normal or non-normal? Explain.

|Time |0 |1 |2 |3 |4 |5 |
|Cash Flow |-$100 |-$50 |$80 |$0 |$100 |$100 |

They’re normal: there is only one change in cash flows from negative to positive.

LG1 2. Derive an accept/reject rule for IRR similar to 13-8 that would make the correct decision on cash flows that are non-normal, but which always have one large positive cash flow at time zero followed by a series of negative cash flows:

|Time |0 |1 |2 |3 |4 |5 |
|Cash Flow Sign |+ |- |- |- |- |- |

With one positive at the beginning and all future cash flows negative, this type of project would be worth more if rates were higher, implying that the NPV profile would be upward-sloping. So the appropriate accept/reject decision rule would look like

Accept Project if IRR ≤ Cost of Capital Reject Project if IRR > Cost of Capital

LG1 3. Is it possible for a company to initiate two products that target the same market and are not mutually exclusive?

Sure, as long as the market has room for both products.

LG2 4. Suppose that your company used “APV”, or “All-the-Present Value-Except-CF0”, to analyze capital budgeting projects. What would this rule’s benchmark value be?

Accept Project if APV ≥ -CF0 Reject Project if APV < -CF0

LG3 5. Under what circumstances could Payback and Discounted Payback be equal?

They would be equal if i = 0.

LG5 6. Could a project’s MIRR ever exceed its IRR?

MIRR would be greater than IRR if a project with normal cash flows had a negative NPV.

LG6 7. If you had two mutually