Business Finance Chapter 10 Solutions – from the author

 Solutions to Problems
P10-1. Payback period
LG 2; Basic
a. $42,000  $7,000  6 years
b. The company should accept the project, because 6  8.

P10-2. Payback comparisons

LG 2; Intermediate
a. Machine 1: $14,000  $3,000  4 years, 8 months
Machine 2: $21,000  $4,000  5 years, 3 months
b. Only Machine 1 has a payback faster than 5 years and is acceptable.
c. The firm will accept the first machine because the payback period of 4 years, 8 months is
less than the 5-year maximum payback required by Nova Products.
d. Machine 2 has returns that last 20 years while Machine 1 has only 7 years of returns.
Payback cannot consider this difference; it ignores all cash inflows beyond the payback
period. In this case, the total cash flow from Machine 1 is $59,000 ($80,000  $21,000) less
than Machine 2.
P10-3. Choosing between two projects with acceptable payback periods
LG 2; Intermediate
a.

Project A Project B
Cash Investment Cash Investment
Year Inflows Balance Year Inflows Balance
0 $100,000 0 $100,000
1 $10,000 90,000 1 40,000 60,000
2 20,000 70,000 2 30,000 30,000
3 30,000 40,000 3 20,000 10,000
4 40,000 0 4 10,000 0
5 20,000 5 20,000

Both Project A and Project B have payback periods of exactly 4 years.

b. Based on the minimum payback acceptance criteria of 4 years set by John Shell, both
projects should be accepted. However, because they are mutually exclusive projects, John
should accept Project B.
c. Project B is preferred over A because the larger cash flows are in the early years of the
project. The quicker cash inflows occur, the greater their value.

P10-4. Personal finance: Long-term investment decisions, payback period

LG 4

a. and b.

Project A Project B
Annual Cumulative Annual Cumulative
Business Finance Chapter 10 Solutions – from the author

Year Cash Flow Cash Flow Cash Flow Cash Flow

0 $(9,000) $(9,000) $(9,000) $(9,000)
1 2,200 (6,800) 1,500 (7,500)
2 2,500 (4,300) 1,500 (6,000)
3 2,500 (1,800) 1,500 (4,500)
4 2,000 3,500 (1,000)
5 1,800 4,000
Total Cash Flow 11,000 12,000
Payback Period 3  1,800/2,000  3.9 years 4  1,000/4,000  4.25 years

c. The payback method would select Project A because its payback of 3.9 years is lower than
Project B’s payback of 4.25 years.

d. One weakness of the payback method is that it disregards expected future cash flows as in
the case of Project B.

P10-5. NPV
LG 3; Basic
NPV  PVn  Initial investment
a. N  15, I  9%, PMT  $150,000
Solve for PV  $1,209,103.26
NPV  $1,209,103.26  $1,000,000
NPV  $209,103
NPV = $209,103.26, which means that the project is acceptable.
b. N  15, I  9%, PMT  $320,000
Solve for PV  2,579,420.30
NPV  $2,579,420.30  $2,500,000
NPV  $
NPV = $79,420.30, which means that the project is acceptable.
c. N  15, I  9%, PMT  $365,000
Solve for PV  $2,942,151.28
NPV  $2,942,151.28  $3,000,000
NPV  −$57,848.72
NPV = −$57,848.72, which means that the project is unacceptable.

P10-6. NPV for varying cost of capital

LG 3; Basic
a. 10%
N  8, I  10%, PMT  $5000
Solve for PV  $26,674.63
NPV  PVn  Initial investment
NPV  $26,674.63  $24,000
Business Finance Chapter 10 Solutions – from the author

NPV  $2,674.63
Accept; positive NPV
b. 12%
N  8, I  12%, PMT  $5,000
Solve for PV  $24,838.20
NPV  PVn  Initial investment
NPV  $24,838.20  $24,000
NPV  $838.20
Accept; positive NPV
c. 14%
N  8, I  14%, PMT  $5,000
Solve for PV  $23,194.32
NPV  PVn  Initial investment
NPV  $23,194.32  $24,000
NPV  $805.68
Reject; negative NPV
P10-7. NPV—independent projects
LG 3; Intermediate
Project A
N  10, I  14%, PMT  $4,000
Solve for PV  $20,864.46
NPV $20,864.46  $26,000
NPV $5,135.54
Reject
Project B—PV of Cash Inflows
CF0  $500,000; CF1  $100,000; CF2  $120,000; CF3  $140,000; CF4  $160,000;
CF5  $180,000; CF6  $200,000
Set I  14%
Solve for NPV  $53,887.93
Accept
Project C—PV of Cash Inflows
CF0  $170,000; CF1  $20,000; CF2  $19,000; CF3  $18,000; CF4  $17,000;
CF5  $16,000; CF6  $15,000; CF7  $14,000; CF8  $13,000; CF9  $12,000; CF10 
$11,000,
Set I  14%
Solve for NPV  $83,668.24
Reject
Project D
N  8, I  14%, PMT  $230,000
Solve for PV  $1,066,938.70
NPV PVn  Initial investment
NPV $1,066,939  $950,000
Business Finance Chapter 10 Solutions – from the author

NPV $116,938.70
Accept
Project E—PV of Cash Inflows
CF0  $80,000; CF1  $0; CF2  $0; CF3  $0; CF4  $20,000; CF5  $30,000; CF6  $0;
CF7  $50,000; CF8  $60,000; CF9  $70,000
Set I  14%
Solve for NPV  $9,963.63
Accept

P10-8. NPV
LG 3; Challenge
a. N  5, I  9%, PMT  $385,000
Solve for PV  $1,497,515.74
The immediate payment of $1,500,000 is not preferred because it has a higher present value
than does the annuity.
b. N  5, I  9%, PV  $1,500,000
Solve for PMT  $385,638.69
c. Present valueAnnuity Due  PVordinary annuity  (1  discount rate)
$1,497,515.74 (1.09)  $1,632,292
Calculator solution: $1,632,292
Changing the annuity to a beginning-of-the-period annuity due would cause Simes Innovations
to prefer to make a $1,500,000 one-time payment because the present value of the annuity
due is greater than the $1,500,000 lump-sum option.
d. No, the cash flows from the project will not influence the decision on how to fund the
project. The investment and financing decisions are separate.

P10-9. NPV and maximum return

LG 3; Challenge
a. N  4, I  10%, PMT  $44,400
Solve for PV  $140,742.03
NPV PV  Initial investment
NPV $140,742.03  $150,000
NPV –$9,257.97
At a cost of capital of 10%, the NPV is −$9,258, which means that the project is not
acceptable.
b. As the cost of capital gets lower, the NPV gets higher, so the investment becomes more
attractive. Using a financial calculator, CF0 = –150,000, C01 = 44,400, F01 = 4, IRR =
7.12%

P10-10. NPV—mutually exclusive projects

LG 3; Intermediate
a. and b.
Press A
CF0  −$85,000; CF1  $18,000; F1  8
Business Finance Chapter 10 Solutions – from the author

Set I  15%
Solve for NPV  −$4,228.21
Reject
Press B
CF0  −$60,000; CF1  $12,000; CF2  $14,000; CF3  $16,000; CF4  $18,000;
CF5  $20,000; CF6  $25,000
Set I  15%
Solve for NPV  $2,584.34
Accept
Press C
CF0  −$130,000; CF1  $50,000; CF2  $30,000; CF3  $20,000; CF4  $20,000;
CF5  $20,000; CF6  $30,000; CF7  $40,000; CF8  $50,000
Set I  15%
Solve for NPV  $15,043.89
Accept
c. Ranking—using NPV as criterion

Rank Press NPV

1 C $15,043.89
2 B 2,584.34
3 A 4,228.21

d. Profitability Indexes
Profitability Index   Present Value Cash Inflows  Investment
Press A: $80,771.79  $85,000  0.95
Press B: $62,584.34  $60,000  1.04
Press C: $145,043.89  $130,000  1.12
e. The profitability index measure indicates that Press C is the best, then Press B, then Press A
(which is unacceptable). This is the same ranking as was generated by the NPV rule.
P10-11. Personal finance: Long-term investment decisions, NPV method
LG 3
Key information:
Cost of MBA program $100,000
($50,000 for tuition and $50,000 for lost earnings)
Annual incremental benefit $ 20,000
Time frame (years) 40
Opportunity cost 6.0%
Calculator Worksheet Keystrokes:
CF0  100,000
CF1  20,000
F1  40
Business Finance Chapter 10 Solutions – from the author

Set I  6%
Solve for NPV  $200,926
The financial benefits outweigh the cost of the MBA program.

P10-12. Payback and NPV

LG 2, 3; Intermediate
a.
Project Payback Period
A $40,000  $13,000 3.08 years
B 3  ($10,000  $16,000)  3.63 years
C 2  ($5,000  $13,000)  2.38 years

Project C, with the shortest payback period, is preferred.

b. Worksheet keystrokes

Year Project A Project B Project C

0 $40,000 $40,000 $40,000
1 13,000 7,000 19,000
2 13,000 10,000 16,000
3 13,000 13,000 13,000
4 13,000 16,000 10,000
5 13,000 19,000 7,000

Solve for $2,565.82 $322.53 $5,454.17

NPV
Accept Reject Accept

Project C is preferred using the NPV as a decision criterion.

c. At a cost of 16%, Project C has the highest NPV. Because of Project C’s cash flow
characteristics, high early-year cash inflows, it has the lowest payback period and the highest
NPV.

P10-13. NPV and EVA

LG 3; Intermediate
a. NPV  $2,500,000  $240,000  0.09  $166,667
b. Annual EVA  $240,000 – ($2,500,000 × 0.09)  $15,000
c. Overall EVA  $15,000  0.09  $166,667
In this case, NPV and EVA give exactly the same answer.

P10-14. IRR—Mutually exclusive projects

LG 4; Intermediate
IRR is found by solving:
Business Finance Chapter 10 Solutions – from the author

n
 CFt 
$0    t 
 initial investment
t 1  (1  IRR) 

Most financial calculators have an “IRR” key, allowing easy computation of the internal rate of
return. The numerical inputs are described below for each project.
Project A
CF0  $90,000; CF1  $20,000; CF2  $25,000; CF3  $30,000; CF4  $35,000; CF5  $40,000
Solve for IRR  17.43%
If the firm’s cost of capital is below 17%, the project would be acceptable.
Project B
CF0  $490,000; CF1  $150,000; CF2  $150,000; CF3  $150,000; CF4  $150,000
[or, CF0  $490,000; CF1  $150,000, F1 4]
Solve for IRR  8.62%
The firm’s maximum cost of capital for project acceptability would be 8.62%.
Project C
CF0  $20,000; CF1  $7500; CF2  $7500; CF3  $7500; CF4  $7500; CF5  $7500
[or, CF0  $20,000; CF1  $7500; F1  5]
Solve for IRR  25.41%
The firm’s maximum cost of capital for project acceptability would be 25.41%.
Project D
CF0  $240,000; CF1  $120,000; CF2  $100,000; CF3  $80,000; CF4  $60,000
Solve for IRR  21.16%
The firm’s maximum cost of capital for project acceptability would be 21% (21.16%).

P10-15. IRR
LG 4; Intermediate
The IRR of the project is 4%. Because the IRR is lower than the firm’s cost of capital, the firm
should reject the project. However, note that in this case, the project’s cash flows have the
opposite sign from what we typically see. That is, in this project there is an upfront inflow (not
an outflow) followed by outflows (not inflows) in the latter years. In a sense, the firm is
borrowing money from its customers, receiving $200 up front and paying back $106 in each of
the next two years. In a project like this, the IRR decision rule is the opposite of the normal case.
Because inflows come first followed by outflows, the firm should accept this project precisely
because its IRR is low relative to the cost of capital (borrowing at a low rate is a good thing). To
see this more clearly, calculate the project NPV, and you will see that it is positive:

NPV  200   106 / 1.07    106 / 1.07 2   8.35  0

The NPV is positive, so the project is acceptable.
Business Finance Chapter 10 Solutions – from the author

P10-16. IRR—Mutually exclusive projects

LG 4; Intermediate
a. and b.
Project X
$100,000 $120,000 $150,000 $190,000 $250,000
$0       $500,000
(1  IRR)1
(1  IRR)2 (1  IRR)3 (1  IRR)4 (1  IRR)5
CF0  −$500,000; CF1  $100,000; CF2  $120,000; CF3  $150,000; CF4  $190,000
CF5  $250,000
Solve for IRR  15.67; since IRR  cost of capital, accept the project.
Project Y
$140,000 $120,000 $95,000 $70,000 $50,000
$0       $325,000
(1  IRR)1
(1  IRR) (1  IRR) (1  IRR) (1  IRR)5
2 3 4

CF0  $325,000; CF1  $140,000; CF2  $120,000; CF3  $95,000; CF4  $70,000
CF5  $50,000
Solve for IRR  17.29%; because IRR  cost of capital, accept the project.
c. Project Y, with the higher IRR, is preferred, although both are acceptable.

P10-17. Personal Finance: Long-term investment decisions, IRR method

LG 4; Intermediate
IRR is the rate of return at which NPV equals zero
Computer inputs and output:
N  5, PV  −$25,000, PMT  $6,000
Solve for IRR  6.40%
Required rate of return: 7.5%
Decision: Reject investment opportunity

P10-18. IRR, investment life, and cash inflows

LG 4; Challenge
a. N  10, PV  −$61,450, PMT  $10,000
Solve for I  10.0%
The IRR  cost of capital; reject the project.
b. I  15%, PV  $61,450, PMT  $10,000
Solve for N  18.23 years
The project would have to run a little more than 8 more years to make the project acceptable
with the 15% cost of capital.
c. N  10, I  15%, PV  $61,450
Solve for PMT  $12,244.04

P10-19. NPV and IRR

LG 3, 4; Intermediate
a. N  7, I  10%, PMT  $4,000
Solve for PV  $19,473.68
Business Finance Chapter 10 Solutions – from the author

NPV PV  Initial investment

NPV $19,473.68  $18,250
NPV $1,223.68
b. N  7, PV  $18,250, PMT  $4,000
Solve for I  12.01%
c. The project should be accepted because the NPV  0 and the IRR  the cost of capital.

P10-20. NPV, with rankings

LG 3, 4; Intermediate
a. NPVA  $45,665.50 (N  3, I  15, PMT  $20,000)  $50,000
NPVA  −$4,335.50
Or, using NPV keystrokes
CF0  $50,000; CF1  $20,000; CF2  $20,000; CF3  $20,000
Set I  15%
NPVA  $4,335.50
Reject
NPVB Key strokes
CF0  $100,000; CF1  $35,000; CF2  $50,000; CF3  $50,000
Set I  15%
Solve for NPV  $1,117.78
Accept
NPVC Key strokes
CF0  $80,000;CF1  $20,000; CF2  $40,000; CF3  $60,000
Set I  15%
Solve for NPV  $7,088.02
Accept
NPVD Key strokes
CF0  $180,000; CF1  $100,000; CF2  $80,000; CF3  $60,000
Set I  15%
Solve for NPV  $6,898.99
Accept
b.

Rank Press NPV

1 C $7,088.02
2 D 6,898.99
3 B 1,117.78
4 A 4335.50

c. Using the calculator, the IRRs of the projects are:

Project IRR
A 9.70%
B 15.63%
Business Finance Chapter 10 Solutions – from the author

C 19.44%
D 17.51%

Because the lowest IRR is 9.7%, all of the projects would be acceptable if the cost of capital
was 9.7%.
Note: Because Project A was the only rejected project from the four projects, all that was
needed to find the minimum acceptable cost of capital was to find the IRR of A.

P10-21. All techniques, conflicting rankings

LG 2, 3, 4: Intermediate
a.

Project A Project B
Cash Investment Cash Investment
Year Inflows Balance Year Inflows Balance
0 $150,000 0 $150,000
1 $45,000 105,000 1 $75,000 75,000
2 45,000 60,000 2 60,000 15,000
3 45,000 15,000 3 30,000 15,000
4 45,000 30,000 4 30,000 0
5 45,000 30,000
6 45,000 30,000

$150,000
Payback A   3.33 years  3 years 4 months
$45,000
$15,000
Payback B  2 years  years  2.5 years  2 years 6 months
$30,000
b. At a discount rate of zero, dollars have the same value through time and all that is needed is a
summation of the cash flows across time.
NPVA  ($45,000  6) − $150,000  $270,000  $150,000  $120,000
NPVB  $75,000  $60,000  $120,000  $150,000  $105,000
c. NPVA:
CF0  $150,000; CF1  $45,000; F1  6
Set I  9%
Solve for NPVA  $51,866.34
NPVB:
CF0  $150,000; CF1  $75,000; CF2  $60,000; CF3  $120,000
Set I  9%
Solve for NPV  $51,112.36
d. IRRA:
CF0  $150,000; CF1  $45,000; F1  6
Solve for IRR  19.91%
IRRB:
Business Finance Chapter 10 Solutions – from the author

CF0  $150,000; CF1  $75,000; CF2  $60,000; CF3  $120,000

Solve for IRR  22.71%
e.

Rank
Project Payback NPV IRR
A 2 1 2
B 1 2 1

The project that should be selected is A. The conflict between NPV and IRR is due partially
to the reinvestment rate assumption. The assumed reinvestment rate of Project B is 22.71%,
the project’s IRR. The reinvestment rate assumption of A is 9%, the firm’s cost of capital. On
a practical level, Project B may be selected due to management’s preference for making
decisions based on percentage returns and their desire to receive a return of cash quickly.
f. NPVA:
CF0  $150,000; CF1  $45,000; F1  6
Set I  12%
Solve for NPVA  $35,013
NPVB:
CF0  $150,000; CF1  $75,000; CF2  $60,000; CF3  $30,000; F01 
Set I  12%
Solve for NPV  $37,436
At a cost of capital of 12%, the NPV of Project A is $35,013, and the NPV of Project B is
$37,436. In this case, Project B appears to be the better project, in contrast to the previous
NVP-based rankings which showed Project A to be superior. Notice that Project B pays most
of its cash in the early years. This makes its NPV less sensitive to the cost of capital. The
NPVs of both projects fall as the cost of capital rises, but the NPV of Project A falls more
rapidly.
P10-22. Payback, NPV, and IRR
LG 2, 3, 4; Intermediate
a. Payback period
Balance after 3 years: $95,000  $20,000  $25,000  $30,000  $20,000
3  ($20,000  $35,000)  3.57 years
b. NPV computation
CF0  $95,000; CF1  $20,000; CF2  $25,000; CF3  $30,000; CF4  $35,000
CF5  $40,000
Set I  12%
Solve for NPV  $9,080.60
$20,000 $25,000 $30,000 $35,000 $40,000
$0       $95,000
c. (1  IRR) (1  IRR) (1  IRR) (1  IRR) (1  IRR) 5
1 2 3 4

CF0  $95,000; CF1  $20,000; CF2  $25,000; CF3  $30,000; CF4  $35,000
CF5  $40,000
Solve for IRR  15.36%
Business Finance Chapter 10 Solutions – from the author

d. NPV $9,080; because NPV  0; accept

IRR 15%; because IRR  12% cost of capital; accept
The project should be implemented since it meets the decision criteria for both NPV and
IRR.
P10-23. NPV, IRR, and NPV profiles
LG 3, 4, 5; Challenge
a. and b.
Project A
CF0  $130,000; CF1  $25,000; CF2  $35,000; CF3  $45,000
CF4  $50,000; CF5  $55,000
Set I  12%
NPVA  $15,237.71
Based on the NPV, the project is acceptable because the NPV is greater than zero.
Solve for IRRA  16.06%
Based on the IRR, the project is acceptable because the IRR of 16% is greater than the 12%
cost of capital.
Project B
CF0  $85,000; CF1  $40,000; CF2  $35,000; CF3  $30,000
CF4  $10,000; CF5  $5,000
Set I  12%
NPVB  $9,161.79
Based on the NPV, the project is acceptable because the NPV is greater than zero.
Solve for IRRB  17.75%
Based on the IRR, the project is acceptable because the IRR of 17.75% is greater than the
12% cost of capital.

c.

Data for NPV Profiles

NPV
Business Finance Chapter 10 Solutions – from the author

Discount Rate A B
0% $80,000 $35,000
12% $15,238 $9,161
15% — $ 4,177
16% 0 —
18% — 0

d. The net present value profile indicates that there are conflicting rankings at a discount rate
less than the intersection point of the two profiles (approximately 15%). The conflict in
rankings is caused by the relative cash flow pattern of the two projects. At discount rates
greater than approximately 15%, Project B is preferable; less than approximately 15%,
Project A is better. Based on Thomas Company’s 12% cost of capital, Project A should be
chosen.
e. Project A has an increasing cash flow from Year 1 through Year 5, whereas Project B has a
decreasing cash flow from Year 1 through Year 5. Cash flows moving in opposite directions
often cause conflicting rankings. The IRR method reinvests Project B’s larger early cash
flows at the higher IRR rate, not the 12% cost of capital.

P10-24. All techniques—decision among mutually exclusive investments

LG 2, 3, 4, 5, 6; Challenge

Project
A B C
Cash inflows (years 15) $20,000 $ 31,500 $ 32,500
a. Payback* 3 years 3.2 years 3.4 years
b. NPV* $10,345 $ 10,793 $ 4,310
c. IRR* 19.86% 17.33% 14.59%
*
Supporting calculations follow.
a. Payback Period: Project A: $60,000  $20,000  3 years
Project B: $100,000  $31,500  3.2 years
Project C: $110,000  $32,500  3.4 years
b. NPV
Project A
CF0  $60,000; CF1  $20,000; F1  5
Set I  13%
Solve for NPVA  $10,344.63
Project B
CF0  $100,000; CF1  $31,500; F1  5
Set I  13%
Solve for NPVB  $10,792.78
Project C
CF0  $110,000; CF1  $32,500; F1  5
Set I  13%
Business Finance Chapter 10 Solutions – from the author

Solve for NPVC  $4,310.02

c. IRR
Project A
CF0  $60,000; CF1  $20,000; F1  5
Solve for IRRA  19.86%
Project B
CF0  $100,000; CF1  $31,500; F1  5
Solve for IRRB  17.34%
Project C
CF0  $110,000; CF1  $32,500; F1  5
Solve for IRRC  14.59%
d.

Data for NPV Profiles

NPV
Discount Rate A B C
0% $40,000 $57,500 $52,500
13% $10,345 10,793 4,310
15% 7,043 5,593 0
17% 3,987 0 —
20% 0 — —

The difference in the magnitude of the cash flow for each project causes the NPV to compare
favorably or unfavorably, depending on the discount rate.
e. Even though A ranks higher in Payback and IRR, financial theorists would argue that B is
superior because it has the highest NPV. Adopting B adds $448.15 more to the value of the
firm than does adopting A.
Business Finance Chapter 10 Solutions – from the author

P10-25. All techniques with NPV profile—mutually exclusive projects

LG 2, 3, 4, 5, 6; Challenge
a. Project A
Payback period
Year 1  Year 2  Year 3  $60,000
Year 4  $20,000
Initial investment  $80,000
Payback 3 years  ($20,000  30,000)
Payback 3.67 years
Project B
Payback period
$50,000  $15,000  3.33 years
b. Project A
CF0  $80,000; CF1  $15,000; CF2  $20,000; CF3  $25,000; CF4  $30,000;
CF5  $35,000
Set I  13%
Solve for NPVA  $3,659.68
Project B
CF0  $50,000; CF1  $15,000; F1  5
Set I  13%
Solve for NPVB  $2,758.47
c. Project A
CF0  $80,000; CF1  $15,000; CF2  $20,000; CF3  $25,000; CF4  $30,000;
CF5  $35,000
Solve for IRRA  14.61%
Project B
CF0  $50,000; CF1  $15,000; F1  5
Solve for IRRB  15.24%
d.
Business Finance Chapter 10 Solutions – from the author

Data for NPV Profiles

NPV
Discount Rate A B
0% $45,000 $25,000
13% $3,655 2,755
14.6% 0 —
15.2% — 0

Intersection—approximately 14%
If cost of capital is above 14%, conflicting rankings occur.
The calculator solution is 13.87%.
e. Both projects are acceptable. Both have similar payback periods, positive NPVs, and
equivalent IRRs that are greater than the cost of capital. Although Project B has a slightly
higher IRR, the rates are very close. Because Project A has a higher NPV, accept Project A.

P10-26. Integrative—Multiple IRRs

LG 6; Basic
a. First the project does not have an initial cash outflow. It has an inflow, so the payback is
immediate. However, there are cash outflows in later years. After 2 years, the project’s
outflows are greater than its inflows, but that reverses in year 3. The oscillating cash flows
(positive-negative-positive-negative-positive) make it difficult to even think about how the
payback period should be defined.
b. CF0  $200,000, CF1  920,000, CF2  $1,582,000, CF3  $1,205,200, CF4  $343,200
Set I  0%; Solve for NPV  $0.00
Set I  5%; Solve for NPV  $15.43
Set I  10%; Solve for NPV  $0.00
Set I  15%; Solve for NPV  $6.43
Business Finance Chapter 10 Solutions – from the author

Set I  20%; Solve for NPV  $0.00

Set I  25%; Solve for NPV  $7.68
Set I  30%; Solve for NPV  $0.00
Set I  35%, Solve for NPV  $39.51
c. There are multiple IRRs because there are several discount rates at which the NPV is zero.
d. It would be difficult to use the IRR approach to answer this question because it is not clear
which IRR should be compared to each cost of capital. For example, at 5%, the NPV is
negative, so the project would be rejected. However, at a higher 15% discount rate the NPV
is positive and the project would be accepted.
e. It is best simply to use NPV in a case where there are multiple IRRs due to the changing
signs of the cash flows.
P10-27. Integrative—Conflicting Rankings
LG 3, 4, 5; Intermediate
a. Plant Expansion
CF0  $3,500,000, CF1  1,500,000, CF2  $2,000,000, CF3  $2,500,000, CF4  $2,750,000
Set I  20%; Solve for NPV  $1,911,844.14
Solve for IRR  43.70%
CF1  1,500,000, CF2  $2,000,000, CF3  $2,500,000, CF4  $2,750,000
Set I  20%; Solve for NPV  $5,411,844.14 (This is the PV of the cash inflows).
PI  $5,411,844.14  $3,500,000  1.55
Product Introduction
CF0  $500,000, CF1  250,000, CF2  $350,000, CF3  $375,000, CF4  $425,000
Set I  20%; Solve for NPV  $373,360.34
Solve for IRR  52.33%
CF1  250,000, CF2  $350,000, CF3  $375,000, CF4  $425,000
Set I  20%; Solve for NPV  $873,360.34 (This is the PV of the cash inflows.)
PI  $873,360.34  $500,000  1.75
b.

Rank
Project NPV IRR PI
Plant Expansion 1 2 2
Product Introduction 2 1 1

c. The NPV is higher for the plant expansion, but both the IRR and the PI are higher for the
product introduction project. The rankings do not agree because the plant expansion has a
much larger scale. The NPV recognizes that it is better to accept a lower return on a larger
project here. The IRR and PI methods simply measure the rate of return on the project and
not its scale (and therefore not how much money in total the firm makes from each project).
d. Because the NPV of the plant expansion project is higher, the firm’s shareholders would be
better off if the firm pursued that project, even though it has a lower rate of return.
Business Finance Chapter 10 Solutions – from the author

P10-28. Ethics problem

LG 1, 6; Intermediate
YEAR LED PROJECT SOLAR PROJECT
0 –$4,200,000 –$500,000
1 700,000 60,000
2 700,000 60,000
3 700,000 60,000
4 700,000 60,000
5 1,000,000 60,000
6 700,000 60,000
7 700,000 60,000
8 700,000 60,000
9 700,000 60,000
10 700,000 60,000

a. LED project
CF0  $4,200,000; C01  $700,000; F01 C02  $1,000,000; C03 = $700,000; F02 = 5
I = 10
Solve for NPVLED  $287,473.37
SOLAR project
CF0  $500,000; C01  $60,000; F01 = 10
I = 10
Solve for NPVSOLAR  −$131,325.97
Because the NPV of Led project is positive the company should undertake Led project.
b. Combined project
NPVCOMBINED = NPVLED + NPVSOLAR
= $287,473.37 + ($131,325.97)
= $156,147.40
Even though NPV of the combined project is positive, the company should not take the combined
project. NPV of the LED project is $287,473.37. If the company undertakes combined project,
NPV decreases by −$131,325.97 (NPV of the Solar project.) Hence, it should undertake only the
LED project and not the combined project.

c. If Diane agrees to combine the two projects into a single proposal, the company would not be
maximizing its NPV; on the other hand if she does not agree to combine the projects, David
would not be able to curry favor with his boss. It would not be ethical for Diane to accept David’s
proposal of rolling two projects into one as this leads to reduction in the overall NPV of the
company. The company would be better off by accepting only the LED project and rejecting the
Solar project, which has a negative NPV.