Question
Bill Technologies has a target capital structure which is 40 percent debt and 60 percent equity. The equity will be financed with retained earnings. The
Bill Technologies has a target capital structure which is 40 percent debt and 60 percent equity. The equity will be financed with retained earnings. The companys bonds have a yield to maturity of 10 percent. The companys stock has a beta = 1.1. The risk-free rate is 6 percent, the market risk premium is 5 percent, and the tax rate is 30 percent. The company is considering a project with the following cash flows:
Year | 0 | 1 | 2 | 3 | 4 |
Cash Flow | ($50,000) | 35,000 | 43,000 | 60,000 | -40,000 |
a. What is the projects net present value (NPV)? (15 points)
b. The CEO of Bill Technologies wants to use the IRR criterion, while the CFO favors the NPV method, and you were hired to advise the firm on the best procedure. There are issues or problems associated with the IRR criterion. For example, some projects may have multiple IRRs. Another issue is related to the reinvestment rate assumptions. Still another issue is that there could be a conflict of ranking based on IRR and NPV for some mutually exclusive projects. Discuss why there is a conflict of ranking based on IRR and NPV in capital budgeting in some cases? How do you resolve the conflict when it occurs? (30 points)
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