Your firm presents you with the following cash flows for mutually exclusive projects A and B. The cost of capital for the two projects is 8%.

Year Project A Project B

0 -440 -200

1 241 131

2 293 172

1. Calculate (a) NPV, (b) IRR, (c) MIRR, and (d) PI

2. Which project should be selected, and why?

3. Construct the NPV profile of the two mutually projects. Label your graph completely making sure that you identify the crossover rate as well as the IRR of the two projects

4. Show the calculation of the crossover rate. What is the significance of this rate?

5. Now consider the following project cash flows:

Year Cash Flow

0 -5

1 30

Feb-30

Show the NPV profile and state your capital budgeting decision. Cost of capital is 10%.

WORKING PROBLEMS

Answer the following set of questions in the space provided.

For the next 4 questions: Consider the following project cash flows. Cost of capital is 10%

Year Cash Flow

0 -30

1 15

Feb-25

3 50

6. What is the IRR of this project? Should the project be accepted? Why?

7. Calculate the NPV of the project. Should the project be accepted? Why?

8. Calculate the project’s Profitability index (PI).

9. Calculate the project’s MIRR

10. Two mutually exclusive projects, A and B, have NPV of $2.5m and $2.9m respectively. However, Project A’s IRR is greater than Project B’s IRR. The cross-over rate for the projects’ NPV profiles is 12%. Which of the following statements is true?

a. The projects’ cost of capital is greater than 12%

b. The projects’ cost of capital is less than 12%

c. The projects’ cost of capital is equal to 12%

d. Insufficient information to make any determination

For the next 2 problems (Investment Timing Option): Kim Hotels is interested in developing a new hotel in Seoul. The company estimates that the hotel would require an initial cash outlay of $20 million. Kim expects that the hotel will produce positive cash flows of $3 million a year at the end of the next 20 years. The project’s cost of capital is 13%.

11. What is the project’s net present value?

12. [4 Points]. While Kim expects the cash flows to be $3 million a year, it recognizes that the cash flows could, in fact, be much higher or lower, depending on whether the Korean government imposes a large hotel tax. One year from now, Kim will know whether the tax will be imposed. There is a 50 percent chance that the tax will be imposed, in which case the yearly cash flows will be only $2.2 million. At the same time, there is a 50 percent chance that the tax will not be imposed, in which case the yearly cash flows will be $3.8 million. Kim is deciding whether to proceed with the hotel project today or wait one year to find out whether the tax will be imposed.

If Kim waits a year, the initial investment will remain at $20 million. Assume that all cash flows are discounted at 13%. Should Kim proceed with the project TODAY or wait a year before deciding?

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