Net Present Value (NPV), Internal Rate of Return (IRR), and Discount Rates.
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I'm getting ready to start a Finance class. I'm reading ahead in the book to try and prepare myself for the course. I have a 4.0 GPA and really want to maintain it through graduation; however, this finance book seems like it is pretty daunting! I'm trying to understand these concepts and there are a few problems that I would like to have someone solve so that I know if I'm doing it right. I'm also trying to learn how to use my financial calculator so if the problem results could show not only how to solve the problem but also contain the financial calculator steps involved, I would greatly appreciate it! Here are the problems:
Your corporation is considering two mutually exclusive projects, Project A and Project B. The projects have the following cash flows:
Year Project A Cash Flow Project B Cash Flow
0 -500 -500
1 150 300
2 200 300
3 250 350
4 100 -300
Both projects have a 10% cost of capital.
1. Which project has the higher net present value (NPV)?
2. Which project has the higher internal rate of return (IRR)?
3. At what discount rate would the two projects have the same net present value (NPV)?
4. Which project would you recommend be undertaken by your company? Explain the rationale for the answer.
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Solution Summary
The solution determines the NPV, IRR and discount rates.
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See the attached file.
Some discussion of basics -
The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions. The firm's investment decisions would generally include expansion, acquisition, modernization and replacement of the long-term assets. Sale of a division or business (divestment) is also as an investment decision.
Decisions like the change in the methods of sales distribution, or an advertisement campaign or research and development programs have long-term implications for the firm's expenditures and benefits, and therefore, they should also be evaluated as investment decisions. Several different procedures are available to analyze potential business investments. Some concepts are better than others when it comes to reliability but all provide enough information to get the general scope of the investment. The procedures that provide useful information are the Net present Value (NPV) and IRR.
First, the most important concept ...
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