I only have enough credit for one more question. I am aware that the rule states
ID: 2789998 • Letter: I
Question
I only have enough credit for one more question. I am aware that the rule states you only need to solve a limit of 5 answers. However, in this case there are people who are willing to help answer all of them. If you are one of them, please kindly help me answer all of these questions. Please don't just answer the first question or the five questions, otherwise I'll hit the dislike button. Thank you
Evaluating cash flows with the NPV method The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decision:s Consider this case: Suppose Celestial Crane Cosmetics is evaluating a proposed capital budgeting project (project Alpha) that will require an initial investment of $450,000. The project is expected to generate the following net cash flows: Year Cash Flow Year 1 $300,000 Year 2 $400,000 Year 3 $450,000 Year 4 $425,000 Celestial Crane Cosmetics's weighted average cost of capital is 10%, and project Alpha has the same risk as the firm's average project. Based on the cash flows, what is project Alpha's net present value (NPV)? O $898,930 O $781,678 O $1,231,678 O $331,678 Making the accept or reject decision Celestial Crane Cosmetics's decision to accept or reject project Alpha is independent of its decisions on other projects. If the firm follows the NPV method, it should project Alpha accept reject Which of the following statements best explains what it means when a project has an NPV of $0? when a project has an NPV of $0, the project is earning a profit of $0. A firm should reject any project with an NPV of $0, because the project is not profitable when a project has an NPV of $0, the project is earning a rate of return equal to the project's weighted average cost of capital. It's OK to accept a project with an NPV of $0, because the project is earning the required minimum rate of return O When a project has an NPV of $0, the project is earning a rate of return less than the project's weighted average cost of capital. It's OK to accept the project, as long as the project's profit is positiveExplanation / Answer
1) NPV = (-)Initial Investment + Cash flow of the year x PVIF (rate, n)
NPV = (-)$450000 + $300000 x PVIF(10%, 1) + $400000 x PVIF(10%, 2) + $450000 x PVIF(10%, 3) + $425000 x PVIF(10%, 4) = $781678 (Option 2)
On the basis of NPV, the company should accept the project as it has a positive NPV.
In case NPV is $0, it means project is earning return equal to weighted cost of capital. Its ok to accept the project, since the project is earning minimum acceptable rate of return. (option 2)
2) NPV = (-)$116000 + $37000 x PVIF(10%, 1) + $50400 x PVIF(10%, 2) + $44700 x PVIF(10%, 3) + $41400 x PVIF(10%, 4) = $21149.78 (Option 3)
On the basis of NPV, the company should accept the project as it has a positive NPV.
3) To compute IRR, we need to compute NPV with two different rates, so that we get a negative NPV (with higher rate) and a positive NPV (With a lower rate) and then interpolate the two rates.
Lets take 22%.
NPV = (-)$850000 + $300000 x PVIF(22%, 1) + $425000 x PVIF(22%, 2) + $400000 x PVIF(22%, 3) + $425000 x PVIF(22%, 4) = $93570.527769
Thats too far from $0, let take a higher rate for a more accurate answer. The more closer the rates to IRR, the more accurate will be the answer. Now, lets take 27%
NPV = (-)$850000 + $300000 x PVIF(27%, 1) + $425000 x PVIF(27%, 2) + $400000 x PVIF(27%, 3) + $425000 x PVIF(27%, 4) = $8367.634015
now, lets take 28%
NPV = (-)$850000 + $300000 x PVIF(28%, 1) + $425000 x PVIF(28%, 2) + $400000 x PVIF(28%, 3) + $425000 x PVIF(28%, 4) = (-)$7165.884976
Difference required = $8367.634015
Total Difference = $8367.634015 - (-$7165.884976) = $15533.518991
Interpolating 27% and 28% -
IRR = 27% + (28% - 27%) x 8367.634015 / 15533.518991 = 27.53% (Option 2)
Since, WACC is 8% which is less than the IRR, the company should accept the project sigma.
The firm should select the project with the greatest cash inflows in case of mutually exclusive projects having IRR greater than wacc. (option 1)
4) IRR is the rate at which Present value of cash inflows is equal to the present value of cash outflows. So, we have -
Initial Investment = Present Value of Cash Inflows
Or, Initial Investment = $1,600,000 x PVIF(13.8%, 1) + $3,000,000 x PVIF (13.8%, 2) + $3,000,000 x PVIF (13.8%, 3) + $3,000,000 x PVIF (13.8%, 4)
Or, Initial Investment = $7,546,869
NPV = (-)$7,546,869 + $1,600,000 x PVIF(10%, 1) + $3,000,000 x PVIF (10%, 2) + $3,000,000 x PVIF (10%, 3) + $3,000,000 x PVIF (10%, 4) = $690,000