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ACME, Inc. is considering a number of alternative projects involving the recreational explosives industry. Net cash flows (i.e. after-tax) for each year are listed below
ACME, Inc. is considering a number of alternative projects involving the recreational explosives industry. Net cash flows (i.e. after-tax) for each year are listed below along with initial investments. The firms cost of capital is 12%. The corporate tax rate is 21%. All projects are independent. Cash Flows Project Investment Year 1 Year 2 Year 3 Year 4 Year 5 Bottle Rockets -3,000 1,000 2,000 1,500 M-80 Firecrackers -2,000 500 750 1,000 2,000 Roman Candles -5,000 1,000 1,000 1,500 2,000 5,000 Flowering Sunrise -10,000 2,000 3,000 3,000 2,500 2,500 a. Calculate the payback period for each project. Assume the investment is made immediately and all other cash inflows are received at year-end. All projects that payback in fewer than four years are acceptable. Which projects meet this criterion? 2 b. Calculate the discounted payback period for each project. Assume the investment is made immediately and all other cash inflows are received at year-end. All projects with a discounted payback of fewer than four years are acceptable. Which are acceptable according to this criterion? c. Calculate the NPV for each project. Which are acceptable according to this criterion? d. Calculate the IRR for each project. Which are acceptable according to this criterion? (Hint: set up an equation in Excel that sets the PV of the future cash flows equal to the investment. Set the discount rate as a reference to another cell that you can vary. Now use trial and error to find a discount rate that sets the PV of future cash flows that equal to the investment.) e. Based on our discussion of decision rules, which projects should be chosen? Why? f. Consider M-80 Firecrackers versus Roman Candles. Suppose you had to choose one of the two projects and your boss preferred to use IRR as her investment criterion. Demonstrate to her using incremental cash flows how you can adopt the IRR rule to arrive at the optimal selection between these two projects
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