Capital Budgeting And Project Evaluation: NPV, IRR, MIRR, And Ethical Considerations

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Capital Budgeting and Project Evaluation: NPV, IRR, MIRR, and EthicalConsiderations1.) IRRProject K costs $46,145.75, its expected cash inflows are $10,000 per year for 9 years, and its WACC is 9%.What is the project's IRR?Round your answer to two decimal places.%Using financial calculatorCF =-46,145.75, and CF1–CF9 = 10,000;IRR =15.9624 % ~ 16%2.) Capital budgeting criteriaA firm with a 13% WACC is evaluating two projects for this year'scapital budget. After-tax cash flows,including depreciation, are as follows:012345Project A-$30,000$10,000$10,000$10,000$10,000$10,000Project B-$90,000$28,000$28,000$28,000$28,000$28,000Calculate MIRR foreach project. Round your answers to two decimal places.Project A_______%Project B_______%Terminal value of A = TVA=10,000(1.13)4+ 10,000(1.13)3+ 10,000(1.13)2+ 10,000(1.13)1+ 10,000= 16,304.74 + 14,428.97 + 12769 +11,300 +10,000= 64,802.71Terminal value of B = TVB= 28,000(1.13)4+ 28,000(1.13)3+ 28,000(1.13)2+ 28,000(1.13)1+ 28,000= 181,447.58MIRRA=30,000(1 + MIRR)5= TVA=30,000(1 + MIRR)5= 64,802.71= (1 + MIRR)5= 64,802.71/30,000= (1 + MIRR)5= 2.16= 1 + MIRR = 1.16651=MIRR = 0.16651 or 16.65%MIRRB=90,000(1 + MIRR)5= TVB=90,000(1 + MIRR)5=181,447.58= (1 + MIRR)5=181,447.58/90,000= (1 + MIRR)5= 2.0161= 1 + MIRR =1.1505=MIRR = 0.1505or15.05%3.) Capital budgeting criteria: ethical considerationsA mining company is considering a new project. Because the mine has received a permit, the project wouldbe legal; but it would cause significant harm to a nearby river. The firm could spend an additional $9.66million at Year 0 to mitigate the environmental problem, but it would not be required to do so. Developingthe mine (without mitigation) would cost $57 million, and the expected net cash inflows would be $19million per year for 5 years. If the firm does invest in mitigation, the annual inflows would be $20 million.The risk adjusted WACC is 10%.Calculate the NPV and IRR with mitigation. Round your answers to two decimal places. Enter your answerfor NPV in millions. For example, an answer of $10,550,000 should be entered as 10.55.NPV $______millionCF0=-($57 + $9.66) million =-$66.66million[initial investment with mitigation]

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CF1–CF5= $19 millionWACC = 10%Using financial calculator we haveNPV = 5.3649 millionand IRR= 13.10%4.) Capital budgeting criteria: ethical considerationsAn electric utility is considering a newpower plant in northern Arizona. Power from the plant would be soldin the Phoenix area, where it is badly needed. Because the firm has received a permit, the plant would belegal; but it would cause some air pollution. The company could spend an additional $40 million at Year 0 tomitigate the environmental problem, but it would not be required to do so. The plant without mitigationwould cost $270.46 million, and the expected cash inflows would be $90 million per year for 5 years. If thefirm does invest in mitigation, the annual inflows would be $93.41 million. Unemployment in the area wherethe plant would be built is high, and the plant would provide about 350 good jobs. The risk adjusted WACCis 19%.Calculate the NPV and IRR with mitigation. (Round your answers to two decimal places. Enter your answerfor NPV in millions. For example, an answer of $10,550,000 should be entered as 10.55.)IRR_______%CF0=-($270.46 + $40) million =-$310.46million[initial investment with mitigation]CF1–CF5= $93.41millionWACC = 19%Using financial calculator we haveNPV =-24.84million and IRR= 15.36%Calculate the NPVand IRR without mitigation. Round your answers to two decimal places. Enter youranswer for NPV in millions. For example, an answer of $10,550,000 should be entered as 10.55.IRR_______%CF0=-$270.46 millionCF1–CF5= $90 millionWACC = 19%Using financial calculator we haveNPV = 4.72 million and IRR = 19.78%5.) IRR and NPVA company is analyzing twomutually exclusive projects, S and L, with the following cash flows:01234Project S-$1,000$875.10$260$10$5Project L-$1,000$0$260$400$771.81The company's WACC is 8.0%. What is the IRR of the betterproject? (Hint: The better project may or maynot be the one with the higher IRR.) Round your answer to two decimal places.________%Project SWACC = 8%CF0=-$1,000CF1= $875.10CF2= $260CF3= $10CF4= $5Using financialcalculator we have NPVS=$44.8 and IRRS= 11.9 %TVS= 875.10(1.08)3+ 260(1.08)2+ 10(1.08) + 5= 1102.374 + 303.264+ 10.8 + 5= 1421.44

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MIRRS= 9.19%Project LWACC = 8%CF0=-$1,000CF1= $0CF2= $260CF3= $400CF4= $771.81Usingfinancial calculator we have NPVL= $107.74and IRRL= 11.4%TVL= 0(1.08)3+ 260(1.08)2+ 400(1.08) + 771.81= 0 + 303.264 + 432 + 771.81= 1507.07MIRRL=10.8%Since project L has higher MIRR and NPV, project L should be selected. IRR ofbetter project (project L)is11.4%6.) NPVA project has annual cash flows of $6,500 for the next 10 years and then $5,000 each year for the following10 years. The IRR of this 20-year project is 13.85%. If the firm's WACC is 10%, what is the project's NPV?(Round your answer to the nearest cent.)$_______At IRR, the present value of cost is present value of revenue.The PV of revenue is,PV = 6,500{1/(1+0.1385)1+ 1/(1+0.1385)2+….+ 1/(1+0.1385)10} + 5,000{1/(1+0.1385)11+1/(1+0.1385)12+….+ 1/(1+0.1385)20}=6,500 (5.24679) + 5,000 (1.434048)=34,104.135 + 7,170.24=41,274.375Assuming that the cost is incurred at the beginning. Thus NPV at 10% isNPV =-41,274.375 +6,500{1/(1+0.1)1+ 1/(1+0.1)2+….+ 1/(1+0.1)10} + 5,000{1/(1+0.1)11+1/(1+0.1)12+….+ 1/(1+0.1)20}=-41,274.375 + 6,500 (6.144567) + 5,000 (2.368996)=-41,274.375 + 39,939.686 + 11,844.98=10,510.29NPV = %10,510.297.)Project cash flowEisenhowerCommunications is trying to estimate the first-year net operating cash flow (at Year 1) for aproposed project. The financial staff has collected the following information on the project:Sales revenues$5 millionOperating costs (excluding depreciation)3.5 millionDepreciation1 millionInterest expense1 million

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The company has a 40% tax rate, and its WACC is 11%.(Write out your answers completely. For example, 13 million should be entered as 13,000,000.)What is the project's operating cash flow for the first year (t = 1)? (Round your answer to the nearest cent.)$______Sales Revenue$5 millionOperating cost$3.5 millionDepreciation$1 millionOperating income before taxes$0.5 millionTaxes(40%)$0.2 millionOperating income after taxes$0.3 millionAdd back depreciation$1 millionOperating cash flow$1.3 millionIf this project would cannibalize other projects by $0.5 million of cash flow before taxes per year, howwould this change your answer to part a? Round your answer to the nearest cent.The firm's OCF would now be $______The cannibalization of existing sales needs to be considered in this analysis on an after-tax basis, becausethe cannibalized sales represent sales revenue the firmwould realize without the new project but would loseif the new project is accepted.Thus, the after-tax effect would be to reduce the firm’s operating cash flowby $0.5(1–T) = $0.5(0.6) = $0.3 million.Thus, the firm’s OCF would now be $1 millionrather than $1.3million.Ignore Part b. If the tax rate dropped to 35%, how would that change your answer to part a? Round youranswer to the nearest cent.The firm's operating cash flow would___________increase_____________by $______If thetaxrate fell to 35%, the operating cash flow would change to:Operating income before taxes$0.5 millionTaxes (35%)0.175 millionOperating income after taxes$0.325 millionAdd back depreciation1 millionOperating cash flow$1.325 millionThus, the firm’s operating cash flow would increase by $0.025 million or $25,0008.) Scenario analysisHuang Industries is considering a proposed project whose estimated NPV is $12 million. This estimateassumes that economic conditions will be"average." However the CFO realizes that conditions could bebetter or worse, so she performed a scenario analysis and obtained these results:Economic ScenarioProbability of OutcomeNPVRecession0.05-$54 millionBelow average0.20-$20 millionAverage0.5012 millionAbove average0.2014 millionBoom0.0526 millionCalculate the project's expected NPV, standard deviation, and coefficient of variation. Round your answersto two decimal places. Enter your answers for the project'sexpected NPV and standard deviation in millions.For example, an answer of $13,000,000 should be entered as 13.

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E(NPV)=$______millionσNPV=$______millionCV=______E(NPV) = 0.05(-54) + 0.2(-20) + 0.5*12 + 0.2*14 + 0.05*26=-2.7-4 + 6 + 2.8 + 1.3=$3.4 millionNPV=[0.05(-54–3.4)2+ 0.2(-20–3.4)2+ 0.5*(12–3.4)2+ 0.2*(14–3.4)2+0.05*(26-3.4)2]1/2= [164.738 + 4.68 + 36.98 + 22.472 + 25.538 ]1/2= (254.408)1/2=$15.95 millionCV =$15.95/3.4=4.6919.)Project risk analysisThe Butler-Perkins Company (BPC) must decide between two mutually exclusive projects.Each costs $7,000 and has an expected life of 3 years. Annual project cash flows begin 1year after the initialinvestment and are subject to the following probability distributions:Project AProject BProbabilityCash FlowsProbabilityCash Flows0.2$6,5000.2$00.6$7,0000.6$7,0000.2$7,5000.2$19,000BPC has decided to evaluate theriskier project at 13% and the less-risky project at 8%.What is each project's expected annual cash flow? (Round your answers to two decimalplaces.)Project A. $______Project B. $______Expected annual cash flows:Project A:ProbableProbability×Cash Flow=Cash Flow0.2$6,000$1,2000.6$7,000$4,2000.2$7,500$1,500Expected annual cash flow=$6,900Project B:ProbableProbability×Cash Flow=Cash Flow0.2$0$00.6$7,000$4,2000.2$19,000$3,800Expected annual cash flow=$8,000

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Project A. $6,900Project B. $8,000Project B's standard deviation (σB) is $6,132 and its coefficient of variation (CVB) is 0.77.What are the values of (σA) and (CVA)? Round your answer to two decimal places.σA= $______CVA=______Project A:σA=[(-900)2*0.2 + (100)2*0.6 + (600)2*0.2]1/2= [162000 + 6000 + 72000]1/2= (240000)½=$489.9Project B:σB= [(-8000)2*0.2 + (-1000)2*0.6 + (11000)2*0.2]1/2= [12800000 + 600000 + 24200000]1/2= (37600000)1/2= $6,131.88CVA= $489.9/$6,900 =0.071CVB= $6,131.88/$8,000 = 0.7665.σA= $489.9CVA= 0.07110.)Scenario analysisYour firm, Agrico Products, is considering a tractor that would have a cost of $37,000,would increase pretaxoperating cash flows before taking account of depreciation by$12,000 per year, and would be depreciated on a straight-line basis to zero over 5 years atthe rate of $7,400 per year, beginning the first year. (Thus, annual cash flows would be$12,000 before taxes plus the tax savings that result from $7,400 of depreciation.) Themanagers are having a heated debate about whether the tractor would actually last 5years. The controller insists that she knows of tractors that have lasted only 4 years. Thetreasurer agrees with the controller, but he argues that most tractors actually do give 5years of service. The service manager then states that some last for as long as 8 years.Given this discussion, the CFO asks you to prepare a scenario analysis to determine theimportance of the tractor's life on the NPV. Use a 40% marginal federal-plus-state tax rate,a zero salvage value, and a 8% WACC. Assuming each of the indicated lives has the sameprobability of occurring (probability = 1/3), what is the tractor's expected NPV? (Hint:Usethe 5-year straight-line depreciation for all analyses and ignore the MACRS half-yearconvention for this problem.)Round your answers to two decimal places. Do not round intermediate calculations.Tractor's NPV if actual life is 4 years.$______Tractor's NPV if actual life is 8 years.$______Tractor's expected NPV.

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