Question 11 (10 points)

In Problem 11-13 on page 406 of your book, calculate the NPV, IRR, and MIRR of Project X. (DO NOT do the question as asked in the problem.) CALCULATE ALL YOUR ANSWERS TO TWO DECIMAL PLACES. STATE THE IRR AND MIRR IN PERCENT BUT DO NOT USE A PERCENT SIGN._____________

406 Part 4 Investing in Long-Term Assets: Capital Budgeting 11-13 4 1 3 $430 $50 MIRR A firm is considering two mutually exclusive projects, X and Y, with the following cash flows: 0 2 Project X -$1,000 $110 $300 $700 Project Y -$1,000 $1,100 $90 $55 The projects are equally risky, and their WACC is 11%. What is the MIRR of the project that maximizes shareholder value? CHOOSING MANDATORY PROJECTS ON THE BASIS OF LEAST COST Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise, the highly profitable plant would have to shut down. Two units are available, HCC and LCC (for high and low capital costs, respectively). HCC has a high capital cost but relatively low operating costs, while LCC has a low capital cost but higher operating costs because it uses more electricity. The costs of the units are shown here. Kim's WACC is 7%. 0 2 3 5 Challenging 11-14 Problems 14-22 11-15 HCC-$600,000 - $50,000 - $50,000 -$50,000 -$50,000 - $50,000 LCC -$100,000 - $175,000-$175,000 $175,000-$175,000 -$175,000 a. Which unit would you recommend? Explain. b. If Kim's controller wanted to know the IRRs of the two projects, what would you tell him? c. If the WACC rose to 15% would this affect your recommendation? Explain your answer and the reason this result occurred. NPV PROFILES: TIMING DIFFERENCES An oil-drilling company must choose between two mutually exclusive extraction projects, and each costs $12 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t = 1 of $14.4 million. Under Plan B, cash flows would be $2.1 million per year for 20 years. The firm's WACC is 12%. a. Construct NPV profiles for Plans A and B, identify each project's IRR, and show the approximate crossover rate. b. Is it logical to assume that the firm would take on all available independent, average risk projects with returns greater than 12%? If all available projects with returns greater than 12% have been undertaken, does this mean that cash flows from past investments have an opportunity cost of only 12% because all the company can do with these cash flows is to replace money that has a cost of 12%? Does this imply that the WACC is the correct reinvestment rate assumption for a project's cash flows? Why or why not? NPV PROFILES: SCALE DIFFERENCES A company is considering two mutually exclusive expansion plans. Plan A requires a $40 million expenditure on a large-scale integrated plant that would provide expected cash flows of $6.4 million per year for 20 years. Plan B requires a $12 million expenditure to build a somewhat less efficient, more labor-intensive plant with expected cash flows of $2.72 million per year for 20 years. The firm's WACC is 10% a. Calculate each project's NPV and IRR. b. Graph the NPV profiles for Plan A and Plan B and approximate the crossover rate, c Calculate the crossover rate where the two projects' NPVs are equal. d. Why is NPV better than IRR for making capital budgeting decisions that add to shareholder value? CAPITAL BUDGETING CRITERIA A company has an 11% WACC and is considering two mutually exclusive investments (that cannot be repeated) with the following cash flows: 2 3 6 7 Project A -$300 $387 --$193-$100 $600 $600 -$405 Project B $134 $134 $134 $134 $134 $0 11-16 11-17 0 4 $850 - $180 $134