Chapter 9

1. Garage Inc. has identified the following two mutually exclusive

(i.e. it can only do one or the other but not both) projects with
cash flows as outlined below.

Year Cash Flow (A) Cash Flow (B)

0 -$43,500 -$43,500
1 21,400 6,400
2 18,500 14,700
3 13,800 22,800
4 7,600 25,200

a) If cost of capital (e.g. required return hurdle rate) is 11%,

what is the NPV for each of these projects? Using the NPV rule,
which project would the company select?

b) Over what range of discount rates would the company choose project
A? Project B? At what discount rate would the company be
indifferent between these two projects? Explain.

A. NPV for project A = -43,500 + 21,400/(1.11) + 18,500/(1.11)^2 + 13.800/(1.11)^3 +

7,600/(1.11)^4
NPV = -43,500 + 19,279 + 15,015 + 10,368 + 5,006
NPV = $ 5,891

NPV for project B = -43, 500 + 6,400/(1.11) + 14,700/(1.11)^2 + 22,800/(1.11)^3 +

25,200/(1.11)^4

NPV = $7467

Project B would be selected.

B. 0 = [43,500 – 43,500] + [21,400 – 6,400]/( 1+IRR) + [18,500 – 14,700]/(1+IRR)^2 +

[13,800-22,800]/(1+IRR)^3 + [7,600 – 25,200]/(1+IRR)^4
= 15.1876 %
Discount rates above 15.1876% choose project A
Discount rates below 15.1876% choose project B
 The project would be indifferent between the project at 15.1876%
This is the rate that makes both project equal. This means the NPV profile of one
project cross over the NPV profile of another project. At this rate both projects
are likely to be taken.

2. Megadeth Inc. is considering expanding its local private cemetery

business nation-wide. According to co-CEOs Dave Mustaine and David
Ellefson, the business is “looking up”. The expansion will provide
a net cash inflow of $127,000 during the first year. Messrs.
Mustaine and Ellefson expect cash flows to increase 4% per year
indefinitely citing the rationale that “…death is a growing
business”. The project requires an initial investment of
$1,700,000.

a) If Megadeth Inc. requires an 11% hurdle rate for such

undertakings, should they proceed with the private cemetery
project?
b) Megadeth’s CFO, Kiko Loureiro, is somewhat unsure about the 4%
perpetual growth rate and asks you to determine the break-even
growth rate based on the 11% hurdle rate.

A. Initial investment = $1,700,000

Cash inflow = $127,000
Hurdle rate = 11%
Growth rate = 4%
PV = CF/(r-g) perpetual cashflow
PV = 127,000/(.11-.04)
PV = $1,814,285.71
The PV is greater than the Initial investment so the project would be taken.
B. NPV = 0, let breakeven = g
127,000/(.11-g) -1,700,000 = 0
g = .0353 or 3.53%
3. A project has the following cash flows shown in the table below.
What is the IRR? If the company’s hurdle rate is 12% should it
proceed with the project? What is happening here?
Year Cash Flow
0 $53,000
1 -29,000
2 -37,000
IRR = 53,000 + (-29,000)/(1+IRR) + (-37,000)/(1+IRR)^2
IRR = 15.28%
The project would be taken because the IRR is greater than the hurdle rate of
12%.