Here are the net cash flows (in thousands of dollars): PLEASE SHOW WORK
Expected Net Cash Flows
Year Franchise L Franchise S
0 ($120) ($120)
1 20 90
2 70 15
3 85 60
Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows.
You also have made subjective risk assessments of each franchise, and concluded that both franchises have risk characteristics that require a return of 14%. You must now determine whether one or both of the franchises should be accepted.
1. What is the difference between independent and mutually exclusive projects?
2. What is each franchise’s NPV?
3. What is the rationale behind the NPV method? According to NPV, which franchise or franchises should be accepted if they are independent? Mutually exclusive?
4. Would the NPVs change if the cost of capital changed?
5. What is each franchise’s IRR?
6. What is the logic behind the IRR method? According to IRR, which franchises should be accepted if they are independent? Mutually exclusive?
7. Would the franchises’ IRRs change if the cost of capital changed?
8. Draw NPV profiles for Franchises L and S. At what discount rate do the profiles cross?
9. Look at your NPV profile graph without referring to the actual NPVs and IRRs. Which franchise or franchises should be accepted if they are independent? Mutually exclusive? Explain. Are your answers correct at any cost of capital less than 12%?
10. What is the underlying cause of ranking conflicts between NPV and IRR?
11. What does the profitability index (PI) measure? What are the PI’s for Franchises S and L?
12. What is the payback period? Find the paybacks for Franchises L and S.
13. What is the rationale for the payback method? According to the payback criterion, which franchise or franchises should be accepted if the firm’s maximum acceptable payback is 2 years, and if Franchises L and S are independent? If they are mutually exclusive?