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Ch9 7. Calculating IRR [LO5] A firm evaluates all of its projects by applying the IRR
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Chao Pan

Fin260 HW Set 5:

Ch. 9, pp. 306-307:

## 7, 9, 12, 14, 24

Ch. 10, pp. 342—343:

## 2, 4, 6, 7, 24, 32


7. Calculating IRR [LO5] A firm evaluates all of its projects by applying the IRR

rule. If the required return is 14 percent, should the firm accept the following



Year    Cash Flow


0          -$26,000


1          11,000


 2         14,000


 3         10,000

9. Calculating NPV and IRR [LO1, 5] A project that provides annual cash flows


of $15,400 for nine years costs $67,000 today. Is this a good project if the required


return is 8 percent? What if it’s 20 percent? At what discount rate would you be


indifferent between accepting the project and rejecting it?

12. NPV versus IRR [LO1, 5] Garage, Inc., has identified the following two mutually


Year    Cash Flow (A)            Cash Flow (B)


0          -$43,500                      -$43,500

1          21,400                         6,400

2          18,500                         14,700

3          13,800                         22,800

4          7,600                           25,200

  a.  What is the IRR for each of these projects? Using the IRR decision rule, which


project should the company accept? Is this decision necessarily correct?

b.  If the required return is 11 percent, what is the NPV for each of these projects?

c.  Over what range of discount rates would the company choose project A?

Project B? At what discount rate would the company be indifferent between these two


projects? Explain.

14. Problems with IRR [LO5] Light Sweet Petroleum, Inc., is trying to evaluate a


generation project with the following cash flows:


Year    Cash Flow


0          -$45,000,000

1          71,000,000

2          -15,000,000


 a.  If the company requires a return of 12 percent on its investments, should it accept


this project? Why?


  b.  Compute the IRR for this project. How many IRRs are there? Using the IRR


decision rule, should the company accept the project? What’s going on here?


24. Multiple IRRs [LO5] This problem is useful for testing the ability of financial


calculators and spreadsheets. Consider the following cash flows. How many different


IRRs are there? (Hint: Search between 20 percent and 70 percent.) When should we


take this project?

Year    Cash Flow

0          -$ 3,024

1          17,172

2          -36,420

3          34,200

4          -12,000




2. Relevant Cash Flows [LO1] Winnebagel Corp. currently sells 30,000 motor homes


per year at $73,000 each and 14,000 luxury motor coaches per year at $120,000 each.


The company wants to introduce a new portable camper to fill out its product line;


it hopes to sell 25,000 of these campers per year at $19,000 each. An independent


consultant has determined that if Winnebagel introduces the new campers, it should


boost the sales of its existing motor homes by 2,700 units per year and reduce the


sales of its motor coaches by 1,300 units per year. What is the amount to use as the


annual sales figure when evaluating this project? Why?

4. Calculating OCF [LO1] Consider the following income statement:


Sales                713,500

Costs               497,300

Depreciation    87,400

EBIT               128800

Taxes (34%)    43792

Net income      85008


Fill in the missing numbers and then calculate the OCF. What is the depreciation tax



6. Calculating Depreciation [LO1] A piece of newly purchased industrial equipment


costs $1,240,000 and is classified as seven-year property under MACRS. Calculate


the annual depreciation allowances and end-of-the-year book values for this



7. Calculating Salvage Value [LO1] Consider an asset that costs $730,000 and is


depreciated straight-line to zero over its eight-year tax life. The asset is to be used

in a five-year project; at the end of the project, the asset can be sold for $192,000. If


the relevant tax rate is 40 percent, what is the after tax cash flow from the sale of this



24. Comparing Mutually Exclusive Projects [LO4] Vandelay Industries is considering


the purchase of a new machine for the production of latex. Machine A costs


$2,600,000 and will last for six years. Variable costs are 35 percent of sales, and fixed


costs are $195,000 per year. Machine B costs $5,200,000 and will last for nine years.


Variable costs for this machine are 30 percent of sales and fixed costs are $230,000


per year. The sales for each machine will be $10 million per year. The required return


is 10 percent, and the tax rate is 35 percent. Both machines will be depreciated on a

straight-line basis. If the company plans to replace the machine when it wears out on


a perpetual basis, which machine should it choose?

32. Project Evaluation [LO1] Aria Acoustics, Inc. (AAI), projects unit sales for a new


seven-octave voice emulation implant as follows:


Year    Unit Sales

1          84,000

2          98,000

3          113,000

4          106,000

5          79,000 


Production of the implants will require $1,500,000 in net working capital to start and


additional net working capital investments each year equal to 15 percent of the


projected sales increase for the following year. Total fixed costs are $3,400,000 per


year, variable production costs are $265 per unit, and the units are priced at $395


each. The equipment needed to begin production has an installed cost of $17,000,000.


Because the implants are intended for professional singers, this equipment is


considered industrial machinery and thus qualifies as seven-year MACRS property. In


five years, this equipment can be sold for about 20 percent of its acquisition cost. AAI

is in the 35 percent marginal tax bracket and has a required return on all its projects of


18 per-cent. Based on these preliminary project estimates, what is the NPV of the


project? What is the IRR?

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Ch9 7. Calculating IRR [LO5] A firm evaluates all of its projects by applying the IRR
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