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# Principles of Finance: investment, cash flows, NPV, IRR

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4. A firm is considering an investment project that will generate the following operating cash flows over the next three years:

Year 1 Year 2 Year 3
\$3,000 \$4,000 \$5,000

If the initial investment required to undertake this project is \$9,500 and the firm's cost of capital 10%, what is the NPV of the investment? Should the firm undertake the project?

5. A project has a total start-up cost of \$4354.40 and generates the following cash flows:

Year 1 Year 2 Year 3
\$1,000 \$2,000 \$3,000

a. What is the IRR of these cash flows?
b. What does the firm's required return on projects of such risk have to be for this project to be undertaken? Explain.

6. You have two mutually exclusive projects with the following cash flows to the firm:

Year Project A Project B
0 (\$4,000) (\$4,000)
1 \$2,000 \$1,000
2 \$1,500 \$1,500
3 \$1,250 \$1,700
4 \$1,000 \$2,400

The cost of capital is 10%.

a. Estimate the NPV of Project A.
b. Estimate the NPV of Project B.
c. Based on your estimates of each project's NPV, which project should you choose? Explain.
d. Estimate the IRR of Project A and the IRR of Project B. Do these results alter your choice in c) above? Explain.

7. Your firm has limited access to capital markets. As a result, is has only \$20,000,000 to invest among 5 possible projects described below. Based on the profitability index, which of the projects would you accept?

Project Initial Investment NPV
A \$10 million \$3 million
B \$5 million \$2.5 million
C \$15 million \$4 million
D \$10 million \$4 million
E \$5 million \$2 million

#### Solution Preview

4. A firm is considering an investment project that will generate the following operating cash flows over the next three years:

Year 1 Year 2 Year 3
\$3,000 \$4,000 \$5,000

If the initial investment required to undertake this project is \$9,500 and the firm's cost of capital 10%, what is the NPV of the investment? Should the firm undertake the project?

NPV is calculated by finding the present value of each cash flow, including both cash inflows and outflows, discounted at the project's cost of capital.

NPV = sum of CFt where CF is the cash flow
(1 + k)t k is the cost of capital
t is the period

NPV = - 9,500 + 3,000 + 4,000 + 5,000 = 289.63
(1.10)1 (1.10)2 (1.10)3

The firm should undertake the project because NPV is greater than 0.

5. A project has a total start-up cost of \$4,354.40 and generates the following cash flows:

Year 1 Year 2 Year 3
\$1,000 \$2,000 \$3,000

a. What is the IRR of these ...

#### Solution Summary

This solution is comprised of a detailed explanation to compute NPV, IRR, and decide which project to undertake.

\$2.19