Chapter 9, NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA Video Solutions, Fundamentals of Corporate Finance

Problem 1

If a project with conventional cash flows has a payback period less than the project's life, can you definitively state the algebraic sign of the NPV? Why or why not? If you know that the discounted payback period is less than the project's life, what can you say about the NPV? Explain.

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Problem 2

Suppose a project has conventional cash flows and a positive NPV. What do you know about its payback? Its discounted payback? Its profitability index? Its IRR? Explain.

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Problem 3

Payback Period [LO2] Concerning payback:
a. Describe how the payback period is calculated, and describe the information this measure provides about a sequence of cash flows. What is the payback criterion decision rule?
b. What are the problems associated with using the payback period to evaluate cash flows?
c. What are the advantages of using the payback period to evaluate cash flows? Are there any circumstances under which using payback might be appropriate? Explain.

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Problem 4

Discounted Payback [LO3] Concerning discounted payback:
a. Describe how the discounted payback period is calculated, and describe the information this measure provides about a sequence of cash flows. What is the discounted payback criterion decision rule?
b. What are the problems associated with using the discounted payback period to evaluate cash flows?
c. What conceptual advantage does the discounted payback method have over the regular payback method? Can the discounted payback ever be longer than the regular payback? Explain.

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01:38

Problem 5

Average Accounting Return [LO4] Concerning AAR:
a. Describe how the average accounting return is usually calculated, and describe the information this measure provides about a sequence of cash flows. What is the AAR criterion decision rule?
b. What are the problems associated with using the AAR to evaluate a project's cash
flows? What underlying feature of AAR is most troubling to you from a financial perspective? Does the AAR have any redeeming qualities?

Ameer Said

Numerade Educator

Problem 6

Concerning NPV:
a. Describe how NPV is calculated, and describe the information this measure provides about a sequence of cash flows. What is the NPV criterion decision rule?
b. Why is NPV considered a superior method of evaluating the cash flows from a project? Suppose the NPV for a project's cash flows is computed to be $$\$ 2,500$$. What does this number represent with respect to the firm's shareholders?

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01:10

Problem 7

Internal Rate of Return [LO5] Concerning IRR:
a. Describe how the IRR is calculated, and describe the information this measure provides about a sequence of cash flows. What is the IRR criterion decision rule?
b. What is the relationship between IRR and NPV? Are there any situations in which you might prefer one method over the other? Explain.
c. Despite its shortcomings in some situations, why do most financial managers use IRR along with NPV when evaluating projects? Can you think of a situation in which IRR might be a more appropriate measure to use than NPV? Explain.

Jennifer Stoner

Numerade Educator

Problem 8

Concerning the profitability index:
a. Describe how the profitability index is calculated, and describe the information this measure provides about a sequence of cash flows. What is the profitability index decision rule?
b. What is the relationship between the profitability index and NPV? Are there any situations in which you might prefer one method over the other? Explain.

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Problem 9

A project has perpetual cash flows of $C$ per period, a cost of $I$, and a required return of $R$. What is the relationship between the project's payback and its IRR? What implications does your answer have for long-lived projects with relatively constant cash flows?

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03:34

Problem 10

In March 2014, automobile manufacturer BMW announced plans to invest $$\$ 1$$ billion to increase production at its South Carolina plant by 50 percent. BMW apparently felt that it would be better able to compete and create value with U.S-based facilities. Other companies such as Fuji Film and Swiss chemical company Lonza have reached similar conclusions and taken similar actions. What are some of the reasons that foreign manufacturers of products as diverse as automobiles, film, and chemicals might arrive at this same conclusion?

Crystal Wang

Numerade Educator

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Problem 11

What difficulties might come up in actual applications of the various criteria we discussed in this chapter? Which one would be the easiest to implement in actual applications? The most difficult?

Gus Steppen

Numerade Educator

Problem 12

Are the capital budgeting criteria we discussed applicable to not-for-profit corporations? How should such entities make capital budgeting decisions? What about the U.S. government? Should it evaluate spending proposals using these techniques?

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Problem 13

One of the less flattering interpretations of the acronym MIRR is "meaningless internal rate of return." Why do you think this term is applied to MIRR?

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Problem 14

It is sometimes stated that "the net present value approach assumes reinvestment of the intermediate cash flows at the required return." Is this claim correct? To answer, suppose you calculate the NPV of a project in the usual way. Next, suppose you do the following:
a. Calculate the future value (as of the end of the project) of all the cash flows other than the initial outlay assuming they are reinvested at the required return, producing a single future value figure for the project.
b. Calculate the NPV of the project using the single Page 305 future value calculated in the previous step and the initial outlay. It is easy to verify that you will get the same NPV as in your original calculation only if you use the required return as the reinvestment rate in the previous step.

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Problem 15

It is sometimes stated that "the internal rate of return approach assumes reinvestment of the intermediate cash flows at the internal rate of return." Is this claim correct? To answer, suppose you calculate the IRR of a project in the usual way. Next, suppose you do the following:
a. Calculate the future value (as of the end of the project) of all the cash flows other than the initial outlay assuming they are reinvested at the IRR, producing a single future value figure for the project.
b. Calculate the IRR of the project using the single future value calculated in the previous step and the initial outlay. It is easy to verify that you will get the same IRR as in your original calculation only if you use the IRR as the reinvestment rate in the previous step.

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