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Quiz I Solution

1. Accept projects alpha and gamma, and reject project beta. Project alpha and gamma have positive NPVs of INR 14 mn and INR 45 mn respectively, while project beta has a negative NPV of INR -40 mn. 2. Accept project gamma and reject projects alpha and beta. Project gamma has the highest NPV of INR 45 mn. 3. Reject the project. The IRR of 7.10% is less than the cost of capital of 6%, so the NPV would be negative. 4. The IRR of project Delta is 13%. 5. Sunk cost. 6. (i) Project Rho (ii) Project Lamda (iii) Projects

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Deepak Kushwaha
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161 views

Quiz I Solution

1. Accept projects alpha and gamma, and reject project beta. Project alpha and gamma have positive NPVs of INR 14 mn and INR 45 mn respectively, while project beta has a negative NPV of INR -40 mn. 2. Accept project gamma and reject projects alpha and beta. Project gamma has the highest NPV of INR 45 mn. 3. Reject the project. The IRR of 7.10% is less than the cost of capital of 6%, so the NPV would be negative. 4. The IRR of project Delta is 13%. 5. Sunk cost. 6. (i) Project Rho (ii) Project Lamda (iii) Projects

Uploaded by

Deepak Kushwaha
Copyright
© © All Rights Reserved
Available Formats
Download as XLSX, PDF, TXT or read online on Scribd
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1.

You have an opportunity to invest in three independent projects, project alpha, beta and
gamma. The NPVs of these projects are INR 14 mn (Fourteen million), INR -40 mn (minus Forty
million), and INR 45 mn (Forty Five million), respectively. Your firm does not face any constraints
on capital. Which project(s) would you select?

2. If the projects in question 1 are mutually exclusive, and the firm does not face any constraints on capital, then which project(

3. Project Omega has the following cash flows (all figures in INR crores):

The project has an IRR of 7.10 per cent, and its cost of capital is 6 per cent. Select the correct alternative:

4. Project Delta requires INR 50 million as initial investment. It would provide INR 5 million of annual cash inflow
growing at 3% in perpetuity. What is the IRR of the project?

5. Money that a firm has already spent and is irrecoverable, regardless of whether a project is taken or rejected, is called:

6. Consider the following cash flows (INR crores) for two mutually exclusive projects Rho and Lamda:

The internal rates of return of the two projects Rho and Lamba are 18.01% and 27.84%, respectively. The two projects have the
i. The cost of capital for the two projects is 10%, which project would you select?

ii. The cost of capital for the two projects is 12%, which project would you select?

iii. The cost of capital of the two projects is 10.20%, which project would you select and why?

iv. The internal rate of return of the incremental cash flows (i.e., cash flows calculated by deducting the cash flows of one proje

v. When would the NPV and the IRR rule suggest the selection of project Lamda?
a. Accept project alpha and gamma, and reject project beta.

b. Accept project gamma, and reject project alpha and beta.

b. Reject the project

c. 13%

c. Sunk cost

projects have the same NPV at 10.20%. Select the correct alternative for question i to v below:
a. Project Rho

b. Project Lamda

d. Project Lamda, lower payback period

b. 10.20%

c. If the discount rate is greater than 10.20% but lower than 27.84%
Time Project Project Incremental cash flows
0 -50000 -50000 0
1 5000 35000 -30000
2 5000 30000 -25000
3 10000 5000 5000
4 70000 5000 65000
IRR 18.01% 27.84% 10.2011%
NPV at r=10% 14001.78 13783.21

NPV at r=12% 10054.3230685131 11902.31


cash flows r 10.00%

r 12.00%
Question 2. Following are the cash flows expressed in real terms (INR millions) for project Theta:
The nominal cost of capital for this project is 10 per cent and the rate of inflation is estimated at 2%. Calculate the NPV of this

Time CFs_Real Nominal cost of capital 10%


0 -15000 Inflation rate 2%
1 7500 Real cost of capital 7.84%
2 7500
3 7500
Discounting real cash flows with real rate
NPV 4383.07

Or, discount nominal cash flows with nominal rate


Time CFs_Real CFs_Nomial
0 -15000 -15000
1 7500 7650
2 7500 7803
3 7500 7959.06

NPV 4383.07
ted at 2%. Calculate the NPV of this project.

(1+Nominal rate) = (1+Real rate)*(1+Inflation rate)


Question 3. Consider the following cash flows (INR crores) for project Vega:
Time Cash Flows
0 -15000
1 20000
If the discounted payback period for the project is 0.84 years, then what is the net present value of project Vega?

Discounted payback period = Initial Investment / CF received in PV Terms


0.84 = 15000 / {20000/(1+r)}
r = 12%

Time Cash Flows Discounted Cash Flows r 12.00%


0 -15000 -15000
1 20000 17857.1428571429

Discounted
Payback
Period 0.84000

NPV 2857.14
alue of project Vega?

PV Terms
Question 4. You have been asked to compare two alternative types of laptops to buy for your
employees. The first alternative is to buy an inexpensive laptop for about $500. This laptop will be
obsolete in 2 years and is expected to have an annual maintenance cost of $50. The second alternative
is to buy a fairly expensive laptop for $1000. This laptop will be obsolete in 5 years and would cost
$50 in annual maintenance charges. Your opportunity cost of capital is 10%. Select the best alternative
assuming that both the laptops will serve exactly the same purpose.

Time CF_InexpensivCF_Expensive r 10.00%


0 -500 -1000
1 -50 -50
2 -50 -50
3 -50
4 -50
5 -50

Present
value of
all the
cash
flows -586.78 -1189.54

EAC PV = C/r *[1+ PV = C/r *[1+{1/(1+r)^5}]

EAC 338.10 313.80

Laptop 2 is the least expensive option


Laptop 2 should be selected

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