FIN 534 Week 8 Homework Set 4


Use the following information for Questions 1 through 5:

Assume you are presented with the following mutually exclusive investments whose expected net cash
flows are as follows:
Year Project A Project B
0 −$400 −$650
1 −528 210
2 −219 210
3 −150 210
4 1,100 210
5 820 210
6 990 210
7 −325 210
1. Construct NPV profiles for Projects A and B.
2. What is each project’s IRR?
3. If each project’s cost of capital were 10%, which project, if either, should be selected? If the cost
of capital were 17%, what would be the proper choice?
4. What is each project’s MIRR at the cost of capital of 10%? At 17%? (Hint: Consider Period 7 as
the end of Project B’s life.)
5. What is the crossover rate, and what is its significance?
Use the following information for Questions 6 through 8:
The staff of Porter Manufacturing has estimated the following net after-tax cash flows and probabilities for
a new manufacturing process:
Line 0 gives the cost of the process, Lines 1 through 5 give operating cash flows, and Line 5* contains the
estimated salvage values. Porter’s cost of capital for an average-risk project is 10%.
Net After-Tax Cash Flows
0 −$100,000 −$100,000 −$100,000
1 20,000 30,000 40,000
2 20,000 30,000 40,000
3 20,000 30,000 40,000
4 20,000 30,000 40,000
5 20,000 30,000 40,000
5* 0 20,000 30,000
6. Assume that the project has average risk. Find the project’s expected NPV. (Hint: Use expected
values for the net cash flow in each year.)
7. Find the best-case and worst-case NPVs. What is the probability of occurrence of the worst case
if the cash flows are perfectly dependent (perfectly positively correlated) over time
8. Assume that all the cash flows are perfectly positively correlated. That is, assume there are only
three possible cash flow streams over time—the worst case, the most likely (or base) case, and
the best case—with respective probabilities of 0.2, 0.6, and 0.2. These cases are represented by
each of the columns in the table. Find the expected NPV, its standard deviation, and its
coefficient of variation for each probability.
Use the following information for Question 9:
At year-end 2013, Wallace Landscaping’s total assets were $2.17 million and its accounts payable were
$560,000. Sales, which in 2013 were $3.5 million, are expected to increase by 35% in 2014. Total assets
and accounts payable are proportional to sales, and that relationship will be maintained. Wallace typically
uses no current liabilities other than accounts payable. Common stock amounted to $625,000 in 2013,
and retained earnings were $395,000. Wallace has arranged to sell $195,000 of new common stock in
2014 to meet some of its financing needs. The remainder of its financing needs will be met by issuing
new long-term debt at the end of 2014. (Because the debt is added at the end of the year, there will be no
additional interest expense due to the new debt.) Its net profit margin on sales is 5%, and 45% of
earnings will be paid out as dividends.
9. What were Wallace’s total long-term debt and total liabilities in 2013?