Essay about Fin 370 Week 3 Team Assignment

1378 Words May 26th, 2013 6 Pages
FIN370 WK3
Solutions Guide:

1. We focus on free cash flows rather than accounting profits because these are the flows that the firm receives and can reinvest. Only by examining cash flows are we able to correctly analyze the timing of the benefit or cost. Also, we are only interested in these cash flows on an after tax basis as only those flows are available to the shareholder. In addition, it is only the incremental cash flows that interest us, because, looking at the project from the point of the company as a whole, the incremental cash flows are the marginal benefits from the project and, as such, are the increased value to the firm from accepting the project.
2. Although depreciation is not a cash flow item, it does affect the
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b. NPVA = - $100,000 = $32,000 (3.696) - $100,000 = $118,272 - $100,000 = $18,272 NPVB = - $100,000 = $200,000 (0.593) - $100,000 = $118,600 - $100,000 = $18,600 c. $100,000 = $32,000 [PVIFAIRRA%,5 yrs] 3.125 = PVIFAIRRA%,5 yrs Thus, IRRA = 18.03% $100,000 = $200,000 [PVIFIRRB%,5 yrs] .50 = PVIFIRRB%,5 yrs Thus IRRB is just under 15% (14.87%).

d. The conflicting rankings are caused by the differing reinvestment assumptions made by the NPV and IRR decision criteria. The NPV criterion assume that cash flows over the life of the project can be reinvested at the required rate of return or cost of capital, while the IRR criterion implicitly assumes that the cash flows over the life of the project can be reinvested at the internal rate of return.
e. Project B should be taken because it has the largest NPV. The NPV criterion is preferred because it makes the most acceptable assumption for the wealth maximizing firm.

13. a. Payback A = 1.5385 years Payback B = 3.0769 years b. NPVA = - $100,000 = $65,000 (2.322) - $100,000 = $150,930 - $100,000 = $50,930 NPVB = - $100,000 = $32,500 (4.946) - $100,000 = $160,745 - $100,000 = $60,745 c. $100,000 = $65,000 [PVIFAIRRA%,3 yrs] Thus, IRRA = over 40% (42.57%) $100,000 = $32,500 [PVIFAIRRB%,9 yrs] Thus, IRRB = 29%
d. These projects are not comparable because future profitable

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