Problem 1 a.

Calculate the net present value of the following project for discount rates of 0, 50, and 100%: Cash flows ($) C(1) C(2) 4500 18000

C(0) -6750 Answer:

C(0) C(1) C(2) NPV

CF -6750 4500 18000

Present values 0% 50% -6750 -6750 4500 3000 18000 8000 15750 4250

100% -6750 2250 4500 0

b. What is the IRR of the project? Answer: the IRR is the rate such that the NPV=0. Therefore, based on part a, the IRR equals 100%.

50, and 100%:

Problem 2 Consider the project with the following cash flows:

Time: CF:

0 -100

1 200

2 -75

a. Which of the following numbers is the project IRR: (i) -50%; (ii) -12%; (iii) +5%; (iv) +50%

Answer: Rate -50% -12% 5% 50% NPV 0% 3042% 2245% 0%

b. The opportunity cost of capital is 20%. Is this an attractive project? Briefly explain.

Rate 20%

NPV 14.58

Answer: yes this is an attractive project because it has a positive NPV.

Problem 3 Consider projects Alpha and Beta.

Cash flows Project Alpha Beta 0 -400000 -200000 1 241000 131000 2 293000 172000 IRR 21% 31%

a. What are the incremental cash flows from investing in Alpha relative to Beta? Answer: 0 -200000 1 110000 2 IRR 121000

Increment

10%

b. Compute the IRR of the incremental cash flows of Alpha.

Answer: see IRR above. c. The opportunity cost of capital is 8%. Suppose you can undertake Apha or Beta, but not both. Which project should you take? Answer: The IRR on project Beta is greater than 8% and the incremental IRR on Alpha is greater than 8%. Therefore you should take Alpha over Beta.

Problem 4 Calculate the IRR (or IRRs) for the following project:

Time: CF:

0 -3000

1 3500

2 4000

3 -4000

For what range of discount rates does the project have a positive NPV?

Answer: Year 0 1 2 3 PV= CF -3000 3500 4000 -4000 Present value at different rates -17.44% 0% 10% -3000 -3000 -3000 4239 3500 3182 5868 4000 3306 -7108 -4000 -3005 0 500 482 15% -3000 3043 3025 -2630 438 20% -3000 2917 2778 -2315 380 25% -3000 2800 2560 -2048 312

The two IRRs for this project are approximately : -17.44% and 45.27%. Between these two discount rates the NPV

45.27% -3000 2409 1895 -1305 0

these two discount rates the NPV is positive.

Problem 5

The Titanic Shipbuilding Company has a noncancelable contract to build a small cargo vessel. Construction involv $250,000 at the end of each of the next two years. The company can speed up construction by working an extra there will be a cash outlay of $550,000 at the end of the first year followed by a cash payment of $650,000 at the year. Use the IRR rule to show the (approximate) range of opportunity costs of capital at which the company sho shift.

Answer using incremental analysis: Time: 1 Current arrangement -250000 Extra shift 550000 Incremental flows -300000

2 -250000 650000 900000

3 650000 0 -650000

NPV of incremental flows for different rates: Rate NPV -50.00% -1100000 -25.00% -255556 0.00% -50000 15.00% -8885 20.00% -1389 21.13% -3 25.00% 4000 50.00% 11111 75.00% 2041 78.87% -1 80.00% -617 The IRRs for the incremental cash flows are (approximately): 21.13% and 78.87%. If the cost of capital is between these rates, Titanic should work the extra shift.

essel. Construction involves a cash outlay of ction by working an extra shift. In this case ayment of $650,000 at the end of the second at which the company should work the extra