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Matrix Associates Is Evaluating A Project Whose Expected Cash Flows Are As Follows
Matrix Associates Is Evaluating A Project Whose Expected Cash Flows Are As Follows
1. Matrix Associates is evaluating a project whose expected cash flows are as follows:
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Solution:
6 8 9 7
NPV = -23 + -------- + --------- + -------- + ---------
(1.14) ( 1.14)2 ( 1.14)3 ( 1.14)4
= -1.361
Solution:
(iii) What is the NPV* of the project if the reinvestment rate is 18 percent?
Solution:
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(iv) What is the MIRR of the project if the reinvestment rate is 18 percent?
Solution:
23 (1+MIRR)4 = 38.617
= 0.7705
Try 14%
NPV = -16 + 3.2 (0.877) + 4.5 (0.769) + 7 (0.675) + 8.4 (0.592)
= -16 + 2.8064 + 3.4605 + 4.725 + 4.9728
= -0.0353
As this is very nearly zero, the IRR of the project is 14 %
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(iii) What is the NPV * of the project if the reinvestment rate is 16%?
Solution:
Terminal
Value = 3.2 (1.16)3 + 4.5 (1.16)2 + 7 (1.16)1 + 8.4
= 3.2 (1.561) + 4.5 (1.346) + 7 (1.16) + 8.4
= 4.9952 + 6.057 + 8.12 + 8.4
= 27.5722
NPV* = 27.5722 - 16 = 1.5359
(1.12)4
Solution:
16 ( 1 + 1RR*)4 = 27.5722
27.5722
( 1 + 1RR*)4 = = 1.7233
16
1RR* = (1.7233) 1/4 -1
= 1.1457 -1 = 14.57 %
3. Dumas Company is evaluating a project whose expected cash flows are as follows:
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Solution:
(ii)
Solution:
13% 14%
PVIF PV PVIF PV
150,000 0.885 132,750 0.877 131,550
200,000 0.783 156,600 0.769 153,800
300,000 0.693 207,900 0.675 202,500
350,000 0.613 214,550 0.592 207,200
711,800 695,050
711,800 - 700,000
IRR = 13 % + x 1% = 13.70%
711,800 - 695,050
(iii) What is the NPV * of the project if the reinvestment rate is 15% ?
Solution:
1,187,550
NPV * = - 700,000
(1.12)4
= 54,709
122
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(iv) What is the IRR* if the reinvestment rate is 15%?
Solution:
4. You are evaluating a project whose expected cash flows are as follows:
What is the NPV of the project (in '000s) if the discount rate is 10 percent for year 1
and rises thereafter by 2 percent every year?
Solution:
123
Calculate the benefit cost ratio of this investment, if the discount rate is 12
percent.
Solution:
Calculate the benefit cost ratio of this investment, if the discount rate is 18
percent.
Solution:
12432
7. Your company is considering two mutually exclusive projects, A and B. Project A
involves an outlay of Rs.250 million which will generate an expected cash inflow
of Rs.60 million per year for 8 years. Project B calls for an outlay of Rs.100
million which will produce an expected cash inflow of Rs.25 million per year for
8 years. The company's cost of capital is 14 percent.
By extrapolation,
Project B
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(b) Difference in capital outlays between projects A and B is Rs.150 million
Difference in net annual cash flow between projects A and B is Rs.35 million.
NPV of the differential project at 14%
= -150 + 35 x PVIFA (14,8)
= Rs.12.37 million
By extrapolation,
r’’ =16 + (4.344-4.286)/(4.344- 4.207) = 16.42 %
Solution:
Project M
The pay back period of the project lies between 2 and 3 years. Interpolating in
this range we get an approximate pay back period of 2.19 years.
Project N
The pay back period lies between 2 and 3 years. Interpolating in this range we
get an approximate pay back period of 2.25 years.
(b)
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Project M
Cost of capital = 15 % p.a
Discounted pay back period (DPB) lies between 2 and 3 years. Interpolating in
this range we get an approximate DPB of 2.64 years.
Project N
Discounted pay back period (DPB) lies between 2 and 3 years. Interpolating in
this range we get an approximate DPB of 2.89 years.
(c ) Project M
Cost of capital = 15% per annum
NPV = - 240 + 85 x PVIF (15,1)
+ 120 x PVIF (15,2) + 180 x PVIF (15,3)
+ 100 x PVIF (15,4)
= - 240 + 85 x 0.870+120 x 0.756 + 180 x0.658
+ 100 x 0.572
= Rs. 100.31million
Project N
Cost of capital = 12% per annum
NPV = - 240 + 100 x PVIF (15,1)
+ 110 x PVIF (15,2) + 120 x PVIF (15,3)
+ 90 x PVIF (15,4)
=- 240 + 100 x0.870+ 110 x 0.756 + 120 x 0.658
+ 90 x 0.572
= Rs. 60.6 million
Since the two projects are independent and the NPV of each project is positive,
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both the projects can be accepted. This assumes that there is no capital constraint.
(d) Project M
Cost of capital = 12% per annum
NPV = Rs.123.23 million
Project N
Cost of capital = 10% per annum
NPV = Rs.79.59 million
Since the two projects are mutually exclusive, we need to choose the project with
the higher NPV i.e., choose project M.
NOTE: The MIRR can also be used as a criterion of merit for choosing between
the two projects because their initial outlays are equal.
(e) Project M
Project N
Cost of capital: 15% per annum
NPV = Rs.32.57 million
Again the two projects are mutually exclusive. So we choose the project with the
higher NPV, i.e., choose project M.
(f) Project M
Project N
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9. If an equipment costs Rs.350,000 and lasts 6 years, what should be the minimum
annual cash inflow before it is worthwhile to purchase the equipment ? Assume
that the cost of capital is 12 percent
Solution:
Let NCF be the minimum constant annual net cash flow that justifies the
purchase of the given equipment. The value of NCF can be obtained from the
equation
10. If an equipment costs Rs.2.000,000 and lasts 8 years, what should be the
minimum annual cash inflow before it is worthwhile to purchase the equipment ?
Assume that the cost of capital is 14 percent
Solution:
Let NCF be the minimum constant annual net cash flow that justifies the
purchase of the given equipment. The value of NCF can be obtained from the
equation
11. How much can be paid for a machine which brings in an annual cash inflow of
Rs.50,000 for 8 years ? Assume that the discount rate is 15 percent.
Solution:
Define I as the initial investment that is justified in relation to a net annual cash
inflow of Rs.50,000 for 8 years at a discount rate of 15% per annum. The value
of I can be obtained from the following equation
12. How much can be paid for a machine which brings in an annual cash inflow of
Rs.600,000 for 12 years ? Assume that the discount rate is 16 percent.
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Solution:
Define I as the initial investment that is justified in relation to a net annual cash
inflow of Rs.600,000 for 12 years at a discount rate of 16% per annum. The value
of I can be obtained from the following equation
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