# Textbook Problems

Complete the following problems:

1- Payback Period and Net Present Value – If a project with conventional cash flows has a payback period less than the project’s life, can you definitively state the algebraic sign of the NPV? Why or why not? If you know that the discounted payback period is less than the project’s life, what can you say about the NPV: Explain.

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3- Payback Period – Concerning payback:
a- Describe how the payback period is calculated, and describe the information this measure provides about a sequence of cash flos. What is the payback criterion decision rule?
b- What are the problems associated with using the payback period to evaluate cash flows?
c- What are the advantages of using the payback period to evaluate cash flows? Are there any circumstances under which using payback might be appropriate? Explain.

4- Discounted Payback – Concerning Discounted Payback:
a- Describe how the discounted payback period is calculated, and describe the information this measure provides about a sequence of cash flows. What is the discounted payback criterion decision rule?
b- What are the problems associated with using the discounted payback period to evaluate the cash flows?
c- What conceptual advantage does the discounted payback method have over the regular payback method? Can the discounted payback ever be longer than the regular payback? Explain

5- Average Accounting Return – Concerning AAR:
Describe how the average accounting return is usually calculated, and describe the information this measure provides about a sequence of cash flows. What is the AAR criterion decision rule?
b- What are the probelms associated with using the AAR to evaluate a project’s cash flows? What underlying feature of AAR is most troubling to you from a financial perspective? Does the AAR have redeeming qualities?

6- Net Present Value – Concerning NPV:
a- Describe how NPV is calculated, and describe the information this measure provides about a sequence of cash flows. What is the NPV criterion decision rule?
b- Why is NPV considereda superior method of evaluating the cash flows from a project? Suppose the NPV for a project’s cash flows is computed to be \$2,500. What does this number represent with respect to the firm’s shareholders?

7- Internal Rate of Return – Concerning IRR:
a- Describe how the IRR is calculated, and describe the information this measure provides about a sequence of cash flows. What is the IRR criterion decision rule?
b- What is the relationship between IRR and NVP? Are there any situations in which yoyu might prefer one method over the other? Explain
c- Despite its shortcomings in some situations, why do most financial managers use IRR along with NPV when evaluating projects? Can you think of a situation in which IRR might be a more appropriate measure to use than NPV? Explain.

8- Profitability Index – Concerning the profitability index:
a- Describe how the profitability index is calculated, and describe the infirmation this measure provides about a sequence of cash flows. What is the profitability index decision rule?
b- What is the relationship between the profitability index and NPV? Are there any situations in which you might prefer one method over the other? Explain

12- NVP versus IRR – Bruin, Inc., has identified the following two mutually exlusive projects:
Year Cash Flow (A) Cash Flow (B)
0 -\$37,500 -\$37,500
1 \$17,300 \$ 5,700
2 \$16,200 \$12,900
3 \$13,800 \$16,300
4 \$ 7,600 \$27,500

a- What is the IRR for each of the these project’s? Using the IRR decision rule, which project should the company accept? Is this decision necessarily correct?
b- If the required return is 11%, what is the NPV for each of these projects? Which project will the company choose if it applies the NPV decision rule?
c- Over what range of discounted rates would the company choose project A or project B? At what discounted rate would the company be indifferent between these tow projects? Explain

15- Calculating Profitability Index – What is the profitability index for the following set of of chas flows if the relevant discount rate is 10%? What if the discount rate is 15%? If it is 22%?

Year Cash Flow
0 -\$16,700
1 \$ 9,700
2 \$ 7,800
3 \$ 4,300

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