Beruflich Dokumente
Kultur Dokumente
Net Income
$150,000
$200,000
$300,000
$450,000
$500,000
Depreciation
$200,000
$200,000
$200,000
$200,000
$200,000
$350,000
$400,000
$500,000
$650,000
$700,000
$(1,000,000)
Net Income
$440,000
$240,000
$140,000
$ 40,000
$ 40,000
Depreciation
$160,000
$160,000
$160,000
$160,000
$160,000
$600,000
$400,000
$300,000
$200,000
$200,000
$(800,000)
Questions:
1. Calculate the Payback Period of each project. Explain what arguments Tim
should make to show that the Payback is not appropriate in this case.
2. Calculate the Discounted Payback Period (DPP) using 10% as the discount
rate (required rate of return). How is the DPP an improvement over the
regular Payback Period? Should Tim ask the Board to use the DPP as the
deciding factor? Explain.
3. The Accounting Rate of Return (ARR), also called the Book Rate of Return,
is calculated as the projects average net income divided by average book
value over the projects economic life. When choosing among mutually
exclusive alternatives, the ARR rule would pick the project with the highest
ARR among projects exceeding the hurdle rate. If management sets a hurdle
for the accounting rate of return of 40% accounting rate of return, which
project would be accepted? What is wrong with the ARR and this decision?
4. Calculate the IRR for each project. Tim wants to convince the Board that the
IRR measure can be misleading when choosing between mutually exclusive
alternatives. Why is the IRR decision rule unreliable in making the correct
choice between the two projects? Tims presentation should inform the
board on the different reinvestment assumptions underlying IRR and NPV
and how that relates to the reliability of the IRR decision rule.
5. An NPV profile graphs the relationship between a projectss NPV and the
discount rate (see Figure 5.6 in Chapter 5). The NPV profiles of mutually
exclusive projects highlight the possible conflict in the decisions made by
NPV and IRR and the importance of the crossover point. Construct the NPV
profiles for the two projects. Identify the IRR for both projects on the graph
and explain the relevance of the crossover point. At the cost of capital,
which projects would the NPV and IRR decision rules accept? Tim wants to
point out to the board that NPV is an absolute measure of the monetary
impact of a project on shareholder value and IRR is a relative value that
evaluates the projects return per dollar invested. What argument can Tim
advance to convince the Board that the NPV decisions are always consistent
with maximizing shareholder value?
6. Given the problem of the IRR rule in evaluating mutually exclusive projects,
an Incremental Internal Rate of Return is used as an alternative. Which
project would the Incremental IRR accept? Although not a problem here,
there could be cases in which there are multiple IRRs. In such a case, the
IRR method would be inoperable as there would be no unique IRR. When
would this be the case?
7. Calculate the Profitability Index for each proposal. How does the
Profitability Index relate to NPV? Do the synthetic resin and epoxy resin
projects significantly differ in scale? Can the Profitability Index rule be
applied here? Explain?