Question;6-21. You;are deciding between two mutually exclusive investment opportunities. Both;require the same initial investment of $10 million. Investment A will generate;$2 million per year (starting at the end of the first year) in perpetuity.;Investment B will generate $1.5 million at the end of the first year and its;revenues will grow at 2% per year for every year after that.;a. Which investment has the higher IRR?;b. Which investment has the higher NPV when;the cost of capital is 7%?;c. In this case, for what values of the cost;of capital does picking the higher IRR give the correct answer as to which;investment is the best opportunity?;6-22. You;have just started your summer internship, and your boss asks you to review a;recent analysis that was done to compare three alternative proposals to enhance;the firm?s manufacturing facility. You find that the prior analysis ranked the;proposals according to their IRR, and recommended the highest IRR option;Proposal A. You are concerned and decide to redo the analysis using NPV to;determine whether this recommendation was appropriate. But while you are;confident the IRRs were computed correctly, it seems that some of the;underlying data regarding the cash flows that were estimated for each proposal;was not included in the report. For Proposal B, you cannot find information;regarding the total initial investment that was required in year 0. And for;Proposal C, you cannot find the data regarding additional salvage value that;will be recovered in year 3. Here is the information you have;Suppose the appropriate cost of;capital for each alternative is 10%. Using this information, determine the NPV;of each project. Which project should the firm choose?;Why is ranking the projects by;their IRR not valid in this situation?;6-23. Use;the incremental IRR rule to correctly choose between the investments in Problem;21 when the cost of capital is 7%. At what cost of capital would your decision;change?;6-24. You;work for an outdoor play structure manufacturing company and are trying to;decide between two projects;Use the incremental IRR to;determine the range of discount rates for which each project is optimal to;undertake. Note that you should also include the range in which it does not;make sense to take either project.;6-26. Consider;two investment projects, which both require an upfront investment of $10;million, and both of which pay a constant positive amount each year for the;next 10 years. Under what conditions can you rank these projects by comparing;their IRRs?;6-27. You;are considering a safe investment opportunity that requires a $1000 investment;today, and will pay $500 two years from now and another $750 five years from;now.;a. What is the IRR of this investment?;b. If you are choosing between this investment;and putting your money in a safe bank account that pays an EAR of 5% per year;for any horizon, can you make the decision by simply comparing this EAR with;the IRR of the investment? Explain.;6-28. AOL;is considering two proposals to overhaul its network infrastructure. They have;received two bids. The first bid, from Huawei, will require a $20 million;upfront investment and will generate $20 million in savings for AOL each year for;the next three years. The second bid, from Cisco, requires a $100 million;upfront investment and will generate $60 million in savings each year for the;next three years.;a. What is the IRR for AOL associated with;each bid?;b. If the cost of capital for this investment;is 12%, what is the NPV for AOL of each bid? Suppose Cisco modifies its bid by;offering a lease contract instead. Under the terms of the lease, AOL will pay;$20 million upfront, and $35 million per year for the next three years. AOL?s;savings will be the same as with Cisco?s original bid.;c. Including its savings, what are AOL?s net;cash flows under the lease contract? What is the IRR of the Cisco bid now?;d. Is this new bid a better deal for AOL than;Cisco?s original bid? Explain.;6-29. Natasha?s;Flowers, a local florist, purchases fresh flowers each day at the local flower;market. The buyer has a budget of $1000 per day to spend. Different flowers;have different profit margins, and also a maximum amount the shop can sell.;Based on past experience, the shop has estimated the following NPV of;purchasing each type;What combination of flowers;should the shop purchase each day?;6-30. You;own a car dealership and are trying to decide how to configure the showroom;floor. The floor has 2000 square feet of usable space.You have hired an analyst;and asked her to estimate the NPV of putting a particular model on the floor;and how much space each model requires;In addition, the showroom also;requires office space. The analyst has estimated that office space generates an;NPV of $14 per square foot. What models should be displayed on the floor and;how;6-31. Kaimalino;Properties (KP) is evaluating six real estate investments. Management plans to;buy the properties today and sell them five years from today. The following;table summarizes the initial cost and the expected sale price for each;property, as well as the appropriate discount rate based on the risk of each;venture.;KP has a total capital budget of;$18,000,000 to invest in properties.;a. What is the IRR of each investment?;b. What is the NPV of each investment?;c. Given its budget of $18,000,000, which;properties should KP choose?;d. Explain why the profitably index method;could not be used if KP?s budget were $12,000,000 instead. Which properties;should KP choose in this case?;6-32. Orchid;Biotech Company is evaluating several development projects for experimental;drugs. Although the cash flows are difficult to forecast, the company has come;up with the following estimates of the initial capital requirements and NPVs;for the projects. Given a wide variety of staffing needs, the company has also;estimated the number of research scientists required for each development;project (all cost values are given in millions of dollars).;a. Suppose that Orchid has a total capital;budget of $60 million. How should it prioritize these projects?;b. Suppose in addition that Orchid currently;has only 12 research scientists and does not anticipate being able to hire any;more in the near future. How should Orchid prioritize these projects?;c. If instead, Orchid had 15 research;scientists available, explain why the profitability index ranking cannot be;used to prioritize projects. Which projects should it choose now?;Project;PI;NPV/Headcount;I;1.01;5.1;II;1.27;6.3;III;1.47;5.5;IV;1.25;8.3;V;2.01;5.0.
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