1. Consider projects Alpha and Beta:
Project CF0 C01 C02 IRR(%)
Alpha -400,000 241,000 293,000 21
Beta -200,000 131,000 172,000 31
The opportunity cost of capital is 8%. Suppose the projects are mutually exclusive. Use the IRR rule to make the choice. (Hint: what is the incremental investment in Alpha?)
2. Some professionals believe firmly, even passionately, that ranking projects on IRR is OK if each project's cash flows can be reinvested at the project's IRR. They also say that the NPV rule "assumes that cash flows are reinvested at the opportunity cost of capital." Think carefully about these statements. Are they true? Are they helpful?
3. Calculate the payback, discounted payback, NPV, IRR, MIRR & profitability index for the following: CF0 = -2,000, C01 = 1,000, C02 = 1,000, C03 = 4,000, C04 = 1,000 & C05 = 1,000; the cost of capital is 10%.
4. You purchase a vehicle for $75,000 for your firm. Using IRS guidelines, set up a depreciation schedule on a MACRS and Straight-line basis. (Hint: IRS will set the time structure).
5. Respond to the following comments:
a. "I like the IRR rule. I can use it to rank projects without having to specify a discount rate."
b. I like the Payback rule. As long as the minimum payback period is short, the rule makes sure that the company takes no borderline projects. That reduces risk."