Question 1: How is a project classification scheme (for example, replacement, expansion into new markets, and so forth) used in the capital budgeting process?
Question 2: Explain why the NPV of a relatively long-term project, defined as one for which a high percentage of its cash flows are expected in the distant future, is more sensitive to changes in the cost of capital than is the NPV of a short-term project.
Question 3: Explain why, if two mutually exclusive projects are being compared, the short-term might have the higher ranking under the NPV criterion if the cost of capital is high, but the long-term project might be deemed better it the cost of capital is low. Would changes in the cost of capital ever cause a change in the IRR ranking of two such projects?
Question 4: In what sense is a reinvestment rate assumption embodied in the NPV, IRR and MIRR method? What is the assumed reinvestment rate of each method?
Question 5: Your company is considering two mutually exclusive projects, X and Y, whose costs and cash flows are shown below:
Year X Y
0 (1,000) (1,000)
1 100 1,000
2 300 100
3 400 50
4 700 50