Expert Answer :finance NPV


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NPV and IRR Assessment Assignment
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NPV and IRR Assessment Assignment
You recently went to work for Allied Components Company, a supplier of auto repair parts used
in the after-market with products from Daimler AG, Ford, Toyota, and other automakers. Your
boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two
proposed projects. Project L involves adding a new item to the firm’s ignition system line; it
would take some time to build up the market for this product, so the cash inflows would increase
over time. Project S involves an add-on to an existing line, and its cash flows would decrease
over time. Both projects have 3-year lives because Allied is planning to introduce entirely new
models after 3 years.
Here are the projects’ cash flows (in thousands of dollars):
Depreciation, salvage values, net operating working capital requirements, and tax effects are all
included in these cash flows. The CFO also made subjective risk assessments of each project,
and he concluded that both projects have risk characteristics that are similar to the firm’s average
project. Allied’s WACC is 10%. The two projects are mutually exclusive.
(1) What is the difference between independent and mutually exclusive projects? Between
projects with normal and nonnormal cash flows?
(2) What is each project’s NPV? According to NPV, which project should be accepted?
(3) What is each project’s IRR? According to IRR, which project should be accepted?
(4) Draw NPV profiles for Projects L and S. At what discount rate do the profiles cross?
(5) Define the term modified IRR (MIRR). Find the MIRRs for Projects L and S.
(6) What is the rationale for the payback period? Find the paybacks for Projects L and S.
As a separate project (Project P), the firm is considering sponsoring a pavilion at the upcoming
World’s Fair. The pavilion would cost $800,000, and it is expected to result in $5 million of
incremental cash inflows during its one year of operation. However, it would then take
another year, and $5 million of costs, to demolish the site and return it to its original condition.
Thus, Project P’s expected cash flows (in millions of dollars) look like this:
Cash Flows
The project is estimated to be of average risk, so its WACC is 10%.
(1) What is Project P’s NPV? What is its IRR? Its MIRR?
(2) Draw Project P’s NPV profile. Does Project P have normal or nonnormal cash
flows? Should this project be accepted?

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