Question 1

You are considering the purchase of an investment that would pay you R5,000 per year for Years 1-5, R3,000 per year for Years 6-8, and R2,000 per year for Years 9 and10.If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?

Accepted Answer

To calculate the present value of the investment, we need to discount each cash flow back to its present-day value and then sum them up. Using a financial calculator or Excel, we can calculate that the present value of the investment is R21,937.26. Therefore, if we can purchase this investment for R21,937.26 or less, it would be a good investment given the required rate of return of 14 percent.

Alternatively, we can calculate the present value manually as follows:

PV = (R5,000 / (1 + 0.14)^1) + (R5,000 / (1 + 0.14)^2) + (R5,000 / (1 + 0.14)^3) + (R5,000 / (1 + 0.14)^4) + (R5,000 / (1 + 0.14)^5) + (R3,000 / (1 + 0.14)^6) + (R3,000 / (1 + 0.14)^7) + (R3,000 / (1 + 0.14)^8) + (R2,000 / (1 + 0.14)^9) + (R2,000 / (1 + 0.14)^10)
PV = R4,123.60 + R3,226.81 + R2,525.06 + R1,977.49 + R1,550.68 + R1,413.68 + R1,100.55 + R855.98 + R834.17 + R678.07
PV = R21,937.26

Question 2

The capital budgeting director of Sparrow Corporation is evaluating a project which costs R200,000, is expected to last for 10 years and produce after-tax cash flows, including depreciation, of R44,503 per year.If the firm's required rate of return is 14 percent and its tax rate is 40 percent, what is the project's IRR?

Accepted Answer

To calculate the IRR of the project, we need to determine the discount rate that equates the present value of the cash inflows with the initial investment. We can use trial and error, or a financial calculator or spreadsheet, to find the rate that makes the net present value (NPV) of the project equal to zero.

Using the after-tax cash flows, we can calculate the project's NPV as follows:
NPV = -200,000 + (44,503/0.6) x [1 - 1/(1 + r)^10]
NPV = -200,000 + 74,171.67 x [1 - 1/(1 + r)^10]
where r is the discount rate or IRR.

At an IRR of 14%, for example, we get:
NPV = -200,000 + (44,503/0.6) x [1 - 1/1.14^10]
NPV = -200,000 + 74,171.67 x [1 - 0.259]
NPV = -200,000 + 54,745.79
NPV = -145,254.21

This means that the project has negative NPV at a discount rate of 14%, implying that it does not meet the firm's minimum required rate of return.

Continuing with trial and error, we can find that at an IRR of 18%:
NPV = -200,000 + (44,503/0.6) x [1 - 1/1.18^10]
NPV = -200,000 + 74,171.67 x [1 - 0.182]
NPV = -200,000 + 60,600.00
NPV = -139,400.00

This means that the project has positive NPV at a discount rate of 18%, indicating that it exceeds the required rate of return and is worth considering.

Therefore, the answer is C) 18%.

Question 3

The modified IRR (MIRR) is normally

Accepted Answer

The answer of The modified IRR (MIRR) is normally
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Question 4

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
...

Question 5

Two projects being considered by a firm are mutually exclusive and have the following projected cash flows:  Based only on the information given, which of the two projects would be preferred, and why?

Accepted Answer

Project B has a higher IRR (15%) compared to Project A (10%). This means that Project B will generate a higher return for the firm, making it the preferred choice. The payback period and NPVs are not relevant in this case since they were not used to determine the best project.

Question 6

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
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Question 7

In comparing two mutually exclusive projects of equal size and equal life, which of the following statements is most correct?

Accepted Answer

In mutually exclusive projects of equal size and equal life, the project with the higher NPV may not always have a higher IRR because NPV assumes reinvestment at the cost of capital, while IRR assumes reinvestment at the project's rate of return. Therefore, answer choice A is correct. Similarly, the project with the higher NPV may not always have a higher MIRR because MIRR assumes reinvestment at the cost of capital, while NPV assumes reinvestment at the project's rate of return. Therefore, answer choice B is correct. Finally, the project with the higher IRR may not always have a higher MIRR because IRR assumes reinvestment at the project's rate of return, while MIRR assumes reinvestment at the cost of capital. Therefore, answer choice C is correct. Overall, answer choices A and C are both correct, making answer E the best choice.

Question 8

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
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Question 9

The Coffee Corporation has been presented with an investment opportunity which will yield end of year cash flows of R30,000 per year in Years 1 through 4, R35,000 per year in Years 5 through 9, and R40,000 in Year10.This investment will cost the firm R150,000 today, and the firm's required rate of return is 10 percent.What is the NPV for this investment?

Accepted Answer

The answer of The Coffee Corporation has been presented with...

Question 10

Two fellow financial analysts are evaluating a project with the following net cash flows:  One analyst says that the project has an IRR of between 12 and 13%.The other analyst calculates an IRR of just under 800%, but fears his calculator's battery is low and may have caused an error.You agree to settle the dispute by analysing the project cash flows.Which statement best describes the IRR for this project?

Accepted Answer

The answer of Two fellow financial analysts are evaluating a...

Question 11

Which of the following is most correct? The modified IRR (MIRR) method:

Accepted Answer

The modified IRR (MIRR) method overcomes the problem of multiple rates of return, as well as the problem of cash flow timing and the problem of project size that leads to criticism of the regular IRR method. Additionally, the MIRR method compounds cash flows at the required rate of return. However, it does not always lead to the same ranking decision as NPV for independent projects.

Question 12

Two projects being considered are mutually exclusive and have the following projected cash flows:  At what rate (approximately) do the NPV profiles of Projects A and B cross?

Accepted Answer

The answer of Two projects being considered are mutually exclusive...

Question 13

Project A has a cost of R1,000, and it will produce end-of-year net cash inflows of R500 per year for 3 years.The project's required rate of return is 10 percent.What is the difference between the project's IRR and its MIRR?

Accepted Answer

The answer of Project A has a cost of R1,000,...

Question 14

Two projects being considered are mutually exclusive and have the following cash flows:  If the required rate of return on these projects is 10 percent, which would be chosen and why?

Accepted Answer

The answer of Two projects being considered are mutually exclusive...

Question 15

Project X has a cost of R30,000 at t = 0, and it is expected to produce a uniform cash flow stream for 7 years, i.e., the CF's are the same in Years 1 through 7, and it has a regular IRR of 14 percent.The required rate of return for the project is 12 percent.What is the project's modified IRR (MIRR)?

Accepted Answer

The answer of Project X has a cost of R30,000...

Question 16

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
...

Question 17

Tuna Inc., a large tuna canning firm operating out of Walvis Bay, Namibia, has a new automated production line project it is considering.The project has a cost of R275,000 and is expected to provide after-tax annual cash flows of R73,306 for eight years.The firm's management is uncomfortable with the IRR reinvestment assumption and prefers the modified IRR approach.You have calculated a required rate of return for the firm of 12 percent.What is the project's MIRR?

Accepted Answer

To calculate the MIRR using the modified IRR approach, we need to find the cash flows of the project at the end of the eighth year, using the required rate of return of 12%.

PV of cash inflows = R73,306 * {(1-1/(1+12%)^8)/12%} = R395,814.52
PV of cash outflows = R275,000

Now we need to find the discount rate (r) that equates the present value of the terminal value (TV) of cash inflows and the present value of the cash outflows:

PV(TV) = FCF(8) / (1+r)^8 = PV(inflows)
PV(outflows) = R275,000
TV = PV(inflows) - PV(outflows)

TV = R395,814.52 - R275,000 = R120,814.52

Now solve for r using trial and error or a financial calculator:

NPV = PV(inflows) + PV(TV)

At r = 16%, NPV = -R5,670.89
At r = 15%, NPV = R3,399.25
At r = 14%, NPV = R12,827.19
At r = 13%, NPV = R21,505.06
At r = 12%, NPV = R30,380.55

Therefore, the MIRR of the project using the modified IRR approach is approximately 16.0%. Hence, the best choice is (D).

Question 18

Michigan Mattress Company is considering the purchase of land and the construction of a new plant.The land, which would be bought immediately (at t = 0), has a cost of R100,000 and the building, which would be erected at the end of the first year (t = 1), would cost R500,000.It is estimated that the firm's after-tax cash flow will be increased by R100,000 starting at the end of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 years.What is the approximate payback period?

Accepted Answer

The payback period is the amount of time it takes for the cash inflows to equal the initial investment.

Initial investment = R100,000 + R500,000 = R600,000

Incremental cash flow starting from year 2 = R100,000
Incremental cash flow in year 3 = R100,000 + 10% of R100,000 = R110,000
Incremental cash flow in year 4 = R110,000 + 10% of R110,000 = R121,000
...
Incremental cash flow in year 11 (end of 10th year) = R259,374.21

To find the payback period, we need to determine in which year the incremental cash flows will equal the initial investment of R600,000.

Year 2 incremental cash flow: R100,000
Year 3 incremental cash flow: R110,000
Year 4 incremental cash flow: R121,000
Year 5 incremental cash flow: R133,100
Year 6 incremental cash flow: R146,410

Therefore, it will take approximately 6 years for the incremental cash flows to equal the initial investment of R600,000.

Question 19

An insurance firm agrees to pay you R3,310 at the end of 20 years if you pay premiums of R100 per year at the end of each year of the 20 years.Find the internal rate of return to the nearest whole percentage point.

Accepted Answer

The internal rate of return (IRR) is the interest rate that makes the net present value (NPV) of the cash flows equal to zero. By calculating the IRR for the given cash flows, R100 per year for 20 years and a final payment of R3,310, the IRR is approximately 5%.

Question 20

Below are the returns of Nulook Cosmetics and the "market" over a three-year period:  Nulook finances internally using only retained earnings, and it uses the Capital Asset Pricing Model with a historical beta to determine its required rate of return.Currently, the risk-free rate is 7 percent, and the estimated market risk premium is 6 percent.Nulook is evaluating a project which has a cost today of R2,028 and will provide estimated cash inflows of R1,000 at the end of the next 3 years.What is this project's MIRR?

Accepted Answer

The answer of Below are the returns of Nulook Cosmetics...

Quiz 9: Capital Budgeting Techniques

The modified IRR (MIRR) is normally

Which of the following statements is correct?

Two projects being considered by a firm are mutually exclusive and have the following projected cash flows: Based only on the information given, which of the two projects would be preferred, and why?

Which of the following statements is correct?

In comparing two mutually exclusive projects of equal size and equal life, which of the following statements is most correct?

Which of the following statements is correct?

Which of the following is most correct? The modified IRR (MIRR) method:

Two projects being considered are mutually exclusive and have the following projected cash flows: At what rate (approximately) do the NPV profiles of Projects A and B cross?

Project A has a cost of R1,000, and it will produce end-of-year net cash inflows of R500 per year for 3 years.The project's required rate of return is 10 percent.What is the difference between the project's IRR and its MIRR?

Two projects being considered are mutually exclusive and have the following cash flows: If the required rate of return on these projects is 10 percent, which would be chosen and why?

Which of the following statements is correct?

An insurance firm agrees to pay you R3,310 at the end of 20 years if you pay premiums of R100 per year at the end of each year of the 20 years.Find the internal rate of return to the nearest whole percentage point.