Question
1. Consider two projects with the following (after-tax) cash flows. Project A: CF1 50, CF2 55, CF3 85. Project B: CF1 140. Both projects require
1. Consider two projects with the following (after-tax) cash flows. Project A: CF1 50, CF2 55, CF3 85. Project B: CF1 140. Both projects require an initial investment of 100. Assume the cost of capital for both projects is r 5%.
(a) Compute NPV and IRR for project A.
(b) Compute NPV and IRR for project B.
(c) Assume you replicate project B twice, i.e. reinvest 100 in t 1 and t2. Compute the NPV and IRR of the replicated project.
(d) Consider again the 1-year project B. Compute the (annualized) modified IRR assuming a reinvestment rate of 10%.
(e) Convert project A and project B into equivalent annuities (see slide 47).
2. Consider a two-year project with a 50% chance of success and failure. If successful, the project generates 100 per year, if not it generates 20 per year. The project requires an initial investment of 50 and the discount rate is 10%.
(a) What is the expected NPV?
(b) What is the probability that NPV < 0?
(c) Assume you can terminate the project after one year, i.e. after the first cash flow is realized. If you choose to terminate, you are able to recoup 50 (paid at the end of t 1).
i. What is the expected NPV?
ii. What is the probability that NPV < 0?
iii. What is the value of the option to terminate?
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