Chapter 10

The Basics of Capital Budgeting

ANSWERS TO END-OF-CHAPTER QUESTIONS

10-1 Project classification schemes can be used to indicate how much

analysis is required to evaluate a given project, the level of the
executive who must approve the project, and the cost of capital that
should be used to calculate the project’s NPV. Thus, classification
schemes can increase the efficiency of the capital budgeting process.

10-2 The NPV is obtained by discounting future cash flows, and the
discounting process actually compounds the interest rate over time.
Thus, an increase in the discount rate has a much greater impact on a
cash flow in Year 5 than on a cash flow in Year 1.

10-3 This question is related to Question 10-2 and the same rationale
applies. With regard to the second part of the question, the answer is
no; the IRR rankings are constant and independent of the firm’s cost of
capital.

10-4 The NPV and IRR methods both involve compound interest, and the
mathematics of discounting requires an assumption about reinvestment
rates. The NPV method assumes reinvestment at the cost of capital,
while the IRR method assumes reinvestment at the IRR. MIRR is a
modified version of IRR that assumes reinvestment at the cost of
capital.

10-5 The statement is true. The NPV and IRR methods result in conflicts
only if mutually exclusive projects are being considered since the NPV
is positive if and only if the IRR is greater than the cost of capital.
If the assumptions were changed so that the firm had mutually exclusive
projects, then the IRR and NPV methods could lead to different
conclusions. A change in the cost of capital or in the cash flow
streams would not lead to conflicts if the projects were independent.
Therefore, the IRR method can be used in lieu of the NPV if the
projects being considered are independent.

10-6 Yes, if the cash position of the firm is poor and if it has limited
access to additional outside financing it might be better off to choose
a machine with a rapid payback. But even here, the relationship
between present value and cost would be a better decision tool.

10-7 a. In general, the answer is no. The objective of management should be

to maximize value, and as we point out in subsequent chapters, stock
values are determined by both earnings and growth. The NPV
calculation automatically takes this into account, and if the NPV of
a long-term project exceeds that of a short-term project, the higher

Answers and Solutions: 10 - 1

 future growth from the long-term project must be more than enough to
compensate for the lower earnings in early years.

b. If the same $100 million had been spent on a short-term project--one

with a faster payback--reported profits would have been higher for a
period of years. This is, of course, another reason why firms
sometimes use the payback method.

10-8 Mutually exclusive projects are a set of projects in which only one of
the projects can be accepted. For example, the installation of a
conveyor-belt system in a warehouse and the purchase of a fleet of
forklifts for the same warehouse would be mutually exclusive projects--
accepting one implies rejection of the other. When choosing between
mutually exclusive projects, managers should rank the projects based on
the NPV decision rule. The mutually exclusive project with the highest
positive NPV should be chosen. The NPV decision rule properly ranks
the projects because it assumes the appropriate reinvestment rate is
the cost of capital.

10-9 Project X should be chosen over Project Y. Since the two projects are
mutually exclusive, only one project can be accepted. The decision
rule that should be used is NPV. Since Project X has the higher NPV,
it should be chosen. The cost of capital used in the NPV analysis
appropriately includes risk.

Answers and Solutions: 10 - 2

 SOLUTIONS TO END-OF-CHAPTER PROBLEMS

10-1 $52,125/$12,000 = 4.3438, so the payback is about 4 years.

10-2 Financial Calculator Solution: Input CF0 = -52125, CF1-8 = 12000, I =

12, and then solve for NPV = $7,486.68.

10-3 Financial Calculator Solution: Input CF0 = -52125, CF1-8 = 12000, and
then solve for IRR = 16%.

10-4 Project K’s discounted payback period is calculated as follows:

Annual Discounted @12%

Period Cash Flows Cash Flows Cumulative
0 ($52,125) ($52,125.00) ($52,125.00)
1 12,000 10,714.29 (41,410.71)
2 12,000 9,566.33 (31,844.38)
3 12,000 8,541.36 (23,303.02)
4 12,000 7,626.22 (15,676.80)
5 12,000 6,809.12 (8,867.68)
6 12,000 6,079.57 (2,788.11)
7 12,000 5,428.19 2,640.08
8 12,000 4,846.60 7,486.68

$2,788. 11
The discounted payback period is 6 + years, or 6.51 years.
$5,42 8.19

Alternatively, since the annual cash flows are the same, one can divide
$12,000 by 1.12 (the discount rate = 12%) to arrive at CF1 and then
continue to divide by 1.12 seven more times to obtain the discounted
cash flows (Column 3 values). The remainder of the analysis would be
the same.

10-5 MIRR: PV Costs = $52,125.

FV Inflows:
PV FV
0 1 2 3 4 5 6 7 8
12%
| | | | | | | | |
12,000 12,000 12,000 12,000 12,000 12,000 12,000
× 1.12 12,000
× (1.12)2 13,440
× (1.12)
3 15,053
× (1.12)4
16,859
× (1.12)5 18,882
× (1.12)6 21,148
× (1.12)7 23,686

Integrated Case: 10 - 3
 26,528
52,125 MIRR =
13.89% 147,596
Financial Calculator Solution: Obtain the FVA by inputting N = 8, I =
12, PV = 0, PMT = 12000, and then solve for FV = $147,596. The MIRR
can be obtained by inputting N = 8, PV = -52125, PMT = 0, FV = 147596,
and then solving for I = 13.89%.

10-6 Project A:

Using a financial calculator, enter the following:

CF0 = -15000000
CF1 = 5000000
CF2 = 10000000
CF3 = 20000000

I = 10; NPV = $12,836,213.

Change I = 10 to I = 5; NPV = $16,108,952.

Change I = 5 to I = 15; NPV = $10,059,587.

Project B:

Using a financial calculator, enter the following:

CF0 = -15000000
CF1 = 20000000
CF2 = 10000000
CF3 = 6000000

I = 10; NPV = $15,954,170.

Change I = 10 to I = 5; NPV = $18,300,939.

Change I = 5 to I = 15; NPV = $13,897,838.

10-7 Truck:

Financial Calculator Solution: Input CF0 = -17100, CF1-5 = 5100, I = 14,

and then solve for NPV = $408.71 ≈ $409 and IRR = 1499% ≈ 15%.

MIRR: PV Costs = $17,100.

FV Inflows:
PV FV
0 14% 1 2 3 4 5
| | | | | |
5,100 5,100 5,100 5,100
× 1.14 5,100
× (1.14)2 5,814
× (1.14)3 6,628

Integrated Case: 10 - 4
 7,556
× (1.14)4
8,614
17,100 MIRR = 14.54% (Accept) 33,712
Financial Calculator Solution: Obtain the FVA by inputting N = 5, I =
14, PV = 0, PMT = 5100, and then solve for FV = $33,712. The MIRR can
be obtained by inputting N = 5, PV = -17100, PMT = 0, FV = 33712, and
then solving for I = MIRR = 14.54%.

Pulley:

Financial Calculator Solution: Input CF0 = -22430, CF1-5 = 7500, I = 14,

and then solve for NPV = $3,318.11 ≈ $3,318 and IRR = 20%.

MIRR: PV Costs = $22,430.

FV Inflows:
PV FV
0 1 2 3 4 5
14%
| | | | | |
7,500 7,500 7,500 7,500
× 1.14 7,500
× (1.14)2 8,550
× (1.14)
3 9,747
× (1.14)4 11,112
12,667
22,430 MIRR = 17.19% (Accept) 49,576

Financial Calculator Solution: Obtain the FVA by inputting N = 5, I =

14, PV = 0, PMT = 7500, and then solve for FV = $49,576. The MIRR can
be obtained by inputting N = 5, PV = -22430, PMT = 0, FV = 49576, and
then solving for I = 17.19%.

10-8 Using a financial calculator:

NPVS = $448.86; NPVL = $607.20.

IRRS = 15.24%; IRRL = 14.67%.

MIRR:

PV costsS = $15,000.
FV inflowsS = $29,745.47.
MIRRS = 14.67%.

PV costsL = $37,500.
FV inflowsL = $73,372.16.
MIRRL = 14.37%.

Thus, NPVL > NPVS, IRRS > IRRL, and MIRRS > MIRRL. The scale difference
between Projects S and L results in IRR and MIRR selecting S over L.
However, NPV favors Project L, and hence Project L should be chosen.

Integrated Case: 10 - 5
10-9 a. The IRRs of the two alternatives are undefined. To calculate an
IRR, the cash flow stream must include both cash inflows and
outflows.

b. The PV of costs for the conveyor system is -$556,717, while the PV

of costs for the forklift system is -$493,407. Thus, the forklift
system is expected to be -$493,407 - (-$556,717) = $63,310 less
costly than the conveyor system, and hence the forklifts should be
used.

10-10 Project X: 0 12% 1 2 3 4

| | | | |
-1,000 100 300 400
× 1.12 700.00
× (1.12)2 448.00
× (1.12)3 376.32
140.49
1,000 13.59% = MIRRX 1,664.81

$1,000 = $1,664.81/(1 + MIRRX)4.

Project Y: 0 12% 1 2 3 4
| | | | |
-1,000 1,000 100 50
× 1.12
50.00
× (1.12)2
56.00
× (1.12)3
125.44
1,404.93
1,000 13.10% = MIRRY 1,636.37

$1,000 = $1,636.37/(1 + MIRRY)4.

Thus, since MIRRX > MIRRY, Project X should be chosen.

Alternate step: You could calculate NPVs, see that Project X has the
higher NPV, and just calculate MIRRX.

NPVX = $58.02 and NPVY = $39.94.

10-11 Input the appropriate cash flows into the cash flow register, and then
calculate NPV at 10 percent and the IRR of each of the projects:

Project S: NPVS = $39.14; IRRS = 13.49%.

Project L: NPVL = $53.55; IRRL = 11.74%.

Since Project L has the higher NPV, it is the better project.

IRRL = 11.74%.

10-12 Step 1: Determine the PMT:

Integrated Case: 10 - 6
 0 12% 1 10
| | • • • |
-1,000 PMT PMT

With a financial calculator, input N = 10, I = 12, PV = -1000,

and FV = 0 to obtain PMT = $176.98.

Step 2: Calculate the project’s MIRR:

0 10% 1 2 9 10
| | | • • • | |
-1,000 176.98 176.98 176.98
× 1.10 176.98
194.68
.
.
× (1.10)8 .
× (1.10)9 379.37
417.31
1,000 10.93% = MIRR TV = 2,820.61

FV of inflows: With a financial calculator, input N = 10, I =

10, PV = 0, and PMT = -176.98 to obtain FV = $2,820.61. Then
input
N = 10, PV = -1000, PMT = 0, and FV = 2820.61 to obtain
I = MIRR = 10.93%.

10-13 a. Purchase price $ 900,000

Installation 165,000
Initial outlay $1,065,000

CF0 = -1065000; CF1-5 = 350000; I = 14; NPV = ?

NPV = $136,578; IRR = 19.22%.

b. Ignoring environmental concerns, the project should be undertaken

because its NPV is positive and its IRR is greater than the firm’s
cost of capital.

c. Environmental effects could be added by estimating penalties or any

other cash outflows that might be imposed on the firm to help return
the land to its previous state (if possible). These outflows could
be so large as to cause the project to have a negative NPV, in which
case the project should not be undertaken.

10-14 a. Year Sales Royalties Marketing Net

0 ($20,000) ($20,000)
1 75,000 ($5,000) ($10,000) 60,000
2 52,500 (3,500) (10,000) 39,000
3 22,500 (1,500) 21,000

Payback period = $20,000/$60,000 = 0.33 year.

Integrated Case: 10 - 7
 NPV = $60,000/(1.11)1 + $39,000/(1.11)2 + $21,000/(1.11)3 - $20,000
= $81,062.35.

Using a financial calculator, input CF0 = -20000; CF1 = 60000, CF2 =

39000, CF3 = 21000, and then solve for IRR = 261.90%.

b. Finance theory dictates that this investment should be accepted.

However, ask your students “Does this service encourage cheating?”
If yes, does a businessperson have a social responsibility not to
make this service available?

10-15 Facts: 5 years remaining on lease; rent = $2,000/month; 60 payments

left, payment at end of month.
New lease terms: $0/month for 9 months; $2,600/month for 51 months.

Cost of capital = 12% annual (1% per month).

a. 0 1% 1 2 59 60
| | | • • • | |
-2,000 -2,000 -2,000 -2,000

PV cost of old lease: N = 60; I = 1; PMT = -2000; FV = 0; PV = ?

PV = -$89,910.08.

0 1% 1 9 10 59 60
| | • • • | | • • • | |
0 0 -2,600 -2,600 -2,600

PV cost of new lease: CF0 = 0, CF1-9 = 0; CF10-60 = -2600; I = 1. NPV

= -$94,611.45.

Sharon should not accept the new lease because the present value of
its cost is $94,611.45 - $89,910.08 = $4,701.37 greater than the old
lease.

b. 0 1% 1 2 9 10 59 60
| | | • • • | | • • • | |
-2,000 -2,000 -2,000 PMT PMT PMT
FV of first 9 months’ rent under old lease:
N = 9; I = 1; PV = 0; PMT = -2000; FV = ? FV = $18,737.05.

The FV of the first 9 months’ rent is equivalent to the PV of the

51-period annuity whose payments represent the incremental rent
during months 10-60. To find this value:
N = 51; I = 1; PV = -18737.05; FV = 0; PMT = ? PMT = $470.80.

Thus, the new lease payment that will make her indifferent is $2,000
+ $470.80 = $2,470.80.
Check:

Integrated Case: 10 - 8
 0 1% 1 9 10 59 60
| | • • • | | • • • | |
0 0 -2,470.80 -2,470.80 -2,470.80
PV cost of new lease: CF0 = 0; CF1 - 9 = 0; CF10 - 60 = -2470.80; I = 1.

NPV = -$89,909.99.

Except for rounding; the PV cost of this lease equals the PV cost of
the old lease.
c. Period Old Lease New Lease ∆Lease
0 0 0 0
1-9 -2,000 0 -2,000
10-60 -2,000 -2,600 600

CF0 = 0; CF1-9 = -2000; CF10-60 = 600; IRR = ? IRR = 1.9113%. This is

the periodic rate. To obtain the nominal cost of capital, multiply
by 12: 12(0.019113) = 22.94%.

Check: Old lease terms:

N = 60; I = 1.9113; PMT = -2000; FV = 0; PV = ? PV = -$71,039.17.

New lease terms:

CF0 = 0; CF1-9 = 0; CF10-60 = -2600; I = 1.9113; NPV = ? NPV = -

$71,038.98.

Except for rounding differences; the costs are the same.

10-16 a. The payback periods for Projects A and B are calculated as follows:

Project A Project B
Period Cash flows Cumulative (A) Cash flows Cumulative
(B)
0 ($400) ($400) ($600) ($600)
1 55 (345) 300 (300)
2 55 (290) 300 0
3 55 (235) 50 50
4 225 (10) 50 100
5 225 215 50 150

Project A's payback is 4 + $10/$225 = 4.04 years, while Project B's

payback is 2 years. According to the payback rule, Project B would
be preferred to Project A.

b. The discounted payback periods for Projects A and B are calculated

as follows:
Disc. @ 10% Disc. @ 10%
Project A Project B
Period Cash flows Cumulative (A) Cash flows Cumulative

Integrated Case: 10 - 9
 (B)
0 ($400.00) ($400.00) ($600.00) ($600.00)
1 50.00 (350.00) 272.73 (327.27)
2 45.45 (304.55) 247.93 (79.34)
3 41.32 (263.22) 37.57 (41.77)
4 153.68 (109.55) 34.15 (7.62)
5 139.71 30.16 31.05 23.42

Project A's payback is 4 + $109.55/$139.71 = 4.78 years, meanwhile

Project B's payback is 4 + $7.62/$31.05 = 4.245 years. According to
the discounted payback rule, Project B would be preferred to Project
A.

Integrated Case: 10 - 10
c. Finding net present values, use a financial calculator and enter the
following data:
Project A Project B
CF0 = -400 CF0 = -600
CF1 = 55 CF1 = 300
CF2 = 55 CF2 = 300
CF3 = 55 CF3 = 50
CF4 = 225 CF4 = 50
CF5 = 225 CF5 = 50
I = 10 I = 10
NPV = $30.16 NPV = $23.42

By the NPV criterion, Project A is preferred to Project B.

d. Finding the IRR, use a financial calculator and enter the following:
Project A Project B
CF0 = -400 CF0 = -600
CF1 = 55 CF1 = 300
CF2 = 55 CF2 = 300
CF3 = 55 CF3 = 50
CF4 = 225 CF4 = 50
CF5 = 225 CF5 = 50
IRR = 12.21% IRR = 12.28%
According to the IRR criterion, Project B is preferred to Project A.

e. Project A:
0 10% 1 2 3 4 5
| | | | | |
-400 55 55 55 225
× 1.10 225
× (1.10)2 247.50
× (1.10)
3 66.55
× (1.10)4 73.21
80.53
692.78
$400 = $692.78/(1 + MIRRA )5
MIRRA = 11.61%.

Project B:
0 10% 1 2 3 4 5
| | | | | |
-600 300 300 50 50
× 1.10
50
× (1.10)2
55.00
× (1.10)3
60.50
× (1.10)4
399.30
439.23
1,004.03

$600 = $1,004.03/(1 + MIRRA )5

MIRRA = 10.85%.

Integrated Case: 10 - 11
 According to the MIRR criterion, Project A is the superior project.
10-17 Since the IRR is the cost of capital at which the NPV of a project
equals zero, the projects inflows can be evaluated at the IRR and the
present value of these inflows must equal the initial investment.
Using a financial calculator enter the following:

CF0 = 0
CF1 = 7500
Nj = 10
CF1 = 10000
Nj = 10
I = 10.98; NPV = $65,002.11.

Therefore, the initial investment for this project is $65,002.11.

Using a calculator, the project's NPV can now be solved.

CF0 = -65002.11
CF1 = 7500
Nj = 10
CF1 = 10000
Nj = 10
I = 9; NPV = $10,239.20.

10-18 The MIRR can be solved with a financial calculator by finding the
terminal future value of the cash inflows and the initial present value
of cash outflows, and solving for the discount rate that equates these
two values. In this instance, the MIRR is given, but a cash outflow is
missing and must be solved for. Therefore, if the terminal future
value of the cash inflows is found, it can be entered into a financial
calculator, along with the number of years the project lasts and the
MIRR, to solve for the initial present value of the cash outflows. One
of these cash outflows occurs in Year 0 and the remaining value must be
the present value of the missing cash outflow in Year 2.
Cash inflows Compounding Rate FV in Year 5 @ 10%
CF1 = 202 × (1.10)4 295.75
CF3 = 196 × (1.10)2 237.16
CF4 = 350 × 1.10 385.00
CF5 = 451 × 1.00 451.00
1368.91
Using the financial calculator to solve for the present value of cash
outflows:
N = 5
I = 14.14
PV = ?
PMT = 0
FV = 1368.91
The total present value of cash outflows is $706.62, and since the outflow

Integrated Case: 10 - 12
 for Year 0 is $500, the present value of the Year 2 cash outflow is
$206.62. Therefore, the missing cash outflow for Year 2 is $206.62 ×(1.1)2
= $250.01.
10-19 a. At k = 12%, Project A has the greater NPV, specifically $200.41 as
compared to Project B’s NPV of $145.93. Thus, Project A would be
selected. At k = 18%, Project B has an NPV of $63.68 which is
higher than Project A’s NPV of $2.66. Thus, choose Project B if k =
18%.

b.

N
PV
($
)
1
,000

9
0 0

8
0 0

7
0 0

6
0 0

5
0 0
P
roje
ctA
4
0 0

3
0 0

2
0 0
P
roje
ctB
1
0 0 C
ostof
C
apita
l (%
)
5 1
0 1
5 2
0 2
5 3
0
-100

-200

-300

k NPVA NPVB
0.0% $890 $399
10.0 283 179
12.0 200 146
18.1 0 62
20.0 (49) 41
24.0 (138) 0
30.0 (238) (51)
c. IRRA = 18.1%; IRRB = 24.0%.

d. To find the crossover rate, construct a Project ∆ which is the

difference in the two projects’ cash flows:

Project ∆ =
Year CFA - CFB
0 $ 105
1 (521)
2 (327)
3 (234)
4 466
5 466
6 716
7 (180)
IRR∆ = Crossover rate = 14.53%.

Integrated Case: 10 - 13
 Projects A and B are mutually exclusive, thus, only one of the
projects can be chosen. As long as the cost of capital is greater
than the crossover rate, both the NPV and IRR methods will lead to
the same project selection. However, if the cost of capital is less
than the crossover rate the two methods lead to different project
selections--a conflict exists. When a conflict exists the NPV
method must be used.
Because of the sign changes and the size of the cash flows, Project
∆ has multiple IRRs. Thus, a calculator’s IRR function will not work.
One could use the trial and error method of entering different discount
rates until NPV = $0. However, an HP can be “tricked” into giving the
roots. After you have keyed Project Delta’s cash flows into the cash
flow registers of an HP-10B, you will see an “Error-Soln” message. Now
enter 10  STO  IRR/YR and the 14.53 percent IRR is found. Then
enter 100  STO  IRR/YR to obtain IRR = 456.22%. Similarly, Excel
can also be used.

e. Here is the MIRR for Project A when k = 12%:

PV costs = $300 + $387/(1.12)1 + $193/(1.12)2

+ $100/(1.12)3 + $180/(1.12)7 = $952.00.
TV inflows = $600(1.12)3 + $600(1.12)2 + $850(1.12)1 = $2,547.60.

Now, MIRR is that discount rate which forces the TV of $2,547.60 in

7 years to equal $952.00.

Using a financial calculator enter the following inputs: N = 7, PV

=
-952, PMT = 0, and FV = 2547.60. Then solve for I = MIRRA = 15.10%.
Similarly, MIRRB = 17.03%.

At k = 18%,
MIRRA = 18.05%.
MIRRB = 20.49%.

10-20 a.

NPV
(Millio
nso
fDolla
rs)

30

PlanB
2
4

18

1
2
C
rossoverR
ate=16.07%
6 Plan A
IRR A =20%
2
. 4
k(%)
0 5 1
0 1
5 20 2
5

IRR B =16.7%

Integrated Case: 10 - 14
 The crossover rate is approximately 16 percent. If the cost of
capital is less than the crossover rate, then Plan B should be
accepted; if the cost of capital is greater than the crossover rate,
then Plan A is preferred. At the crossover rate, the two projects’
NPVs are equal. Thus, other criteria such as the IRR must be used to
evaluate the projects. The exact crossover rate is calculated as
16.07 percent, the IRR of Project ∆, the difference between the cash
flow streams of the two projects.

b. Yes. Assuming (1) equal risk among projects, and (2) that the cost
of capital is a constant and does not vary with the amount of
capital raised, the firm would take on all available projects with
returns greater than its 12 percent cost of capital. If the firm
had invested in all available projects with returns greater than 12
percent, then its best alternative would be to repay capital. Thus,
the cost of capital is the correct reinvestment rate for evaluating
a project’s cash flows.

10-21 a. Using a financial calculator, we get:

NPVA = $14,486,808. NPVB = $11,156,893.

IRRA = 15.03%. IRRB = 22.26%.

b.
NPV
(Millions of Dollars)
80

60

40

Crossover Rate = 11.7%

20
IRR S = 22.26%

0
5 10 1 5 20 25 k (%)
-10 IRR A = 15.03%

The crossover rate is somewhere between 11 percent and 12 percent.

The exact crossover rate is calculated as 11.7 percent, the IRR of
Project ∆, which represents the differences between the cash flow
streams of the two projects.

c. The NPV method implicitly assumes that the opportunity exists to

reinvest the cash flows generated by a project at the cost of
capital, while use of the IRR method implies the opportunity to
reinvest at the IRR. The firm will invest in all independent
projects with an NPV > $0. As cash flows come in from these

Integrated Case: 10 - 15
 projects, the firm will either pay them out to investors, or use
them as a substitute for outside capital which, in this case, costs
10 percent. Thus, since these cash flows are expected to save the
firm 10 percent, this is their opportunity cost reinvestment rate.
The IRR method assumes reinvestment at the internal rate of
return itself, which is an incorrect assumption, given a constant
expected future cost of capital, and ready access to capital markets.

10-22 a. The project’s expected cash flows are as follows (in millions of
dollars):

Time Net Cash Flow

0 ($ 2.0)
1 13.0
2 (12.0)
We can construct the following NPV profile:

NPV
(MillionsofD
ollars)

1.5

1.0

0.5

-0.5

-1.0 k(%)
0 100 200 300 400 500

k NPV
0% ($1,000,000)
10 (99,174)
50 1,333,333
80 1,518,519
100 1,500,000
200 1,000,000
300 500,000
400 120,000
410 87,659
420 56,213
430 25,632
450 (33,058)

b. If k = 10%, reject the project since NPV < $0. Its NPV at k = 10%
is equal to -$99,174. But if k = 20%, accept the project because NPV
> $0. Its NPV at k = 20% is $500,000.

Integrated Case: 10 - 16
c. Other possible projects with multiple rates of return could be
nuclear power plants where disposal of radioactive wastes is
required at the end of the project’s life.
d. MIRR @ k = 10%:

PV costs = $2,000,000 + $12,000,000/(1.10)2 = $11,917,355.

FV inflows = $13,000,000 × 1.10 = $14,300,000.
MIRR = 9.54%. (Reject the project since MIRR < k.)

Integrated Case: 10 - 17
 MIRR @ k = 20%:

PV costs = $2,000,000 + $12,000,000/(1.20)2 = $10,333,333.

FV inflows = $13,000,000 × 1.20 = $15,600,000.
MIRR = 22.87%. (Accept the project since MIRR > k.)
Looking at the results, this project’s MIRR calculations lead to the
same decisions as the NPV calculations. However, the MIRR method
will not always lead to the same accept/reject decision as the NPV
method. Decisions in which two mutually exclusive projects are
involved and differ in scale (size), MIRR can conflict with NPV. In
those situations, the NPV method should be used.

10-23 a. Payback A (cash flows in thousands):

Annual
Period Cash Flows Cumulative
0 ($25,000) ($25,000)
1 5,000 (20,000)
2 10,000 (10,000)
3 15,000 5,000
4 20,000 25,000
PaybackA = 2 + $10,000/$15,000 = 2.67 years.
Payback B (cash flows in thousands):
Annual
Period Cash Flows Cumulative
0 ($25,000) ($25,000)
1 20,000 (5,000)
2 10,000 5,000
3 8,000 13,000
4 6,000 19,000
PaybackB = 1 + $5,000/$10,000 = 1.50 years.
b. Discounted payback A (cash flows in thousands):
Annual Discounted @10%
Period Cash Flows Cash Flows Cumulative
0 ($25,000) ($25,000.00) ($25,000.00)
1 5,000 4,545.45 (20,454.55)
2 10,000 8,264.46 (12,190.09)
3 15,000 11,269.72 (920.37)
4 20,000 13,660.27 12,739.90
Discounted PaybackA = 3 + $920.37/$13,660.27 = 3.07 years.
Discounted payback B (cash flows in thousands):
Annual Discounted @10%
Period Cash Flows Cash Flows Cumulative
0 ($25,000) ($25,000.00) ($25,000.00)
1 20,000 18,181.82 (6,818.18)
2 10,000 8,264.46 1,446.28
3 8,000 6,010.52 7,456.80
4 6,000 4,098.08 11,554.88

Integrated Case: 10 - 18
 Discounted PaybackB = 1 + $6,818.18/$8,264.46 = 1.825 years.

c. NPVA = $12,739,908; IRRA = 27.27%.

NPVB = $11,554,880; IRRB = 36.15%.

Both projects have positive NPVs, so both projects should be

undertaken.

d. At a discount rate of 5 percent, NPVA = $18,243,813.

At a discount rate of 5 percent, NPVB = $14,964,829.

At a discount rate of 5 percent, Project A has the higher NPV;

consequently, it should be accepted.

e. At a discount rate of 15 percent, NPVA = $8,207,071.

At a discount rate of 15 percent, NPVB = $8,643,390.

At a discount rate of 15 percent, Project B has the higher NPV;

consequently, it should be accepted.

f. Project ∆ =
Year CFA - CFB
0 $ 0
1 (15)
2 0
3 7
4 14

IRR∆ = Crossover rate = 13.5254% ≈ 13.53%.

g. Use 3 steps to calculate MIRRA @ k = 10%:

Step 1: Calculate the NPV of the uneven cash flow stream, so its FV
can then be calculated. With a financial calculator, enter
the cash flow stream into the cash flow registers, then
enter I = 10, and solve for NPV = $37,739,908.

Step 2: Calculate the FV of the cash flow stream as follows:

Enter N = 4, I = 10, PV = -37739908, and PMT = 0 to solve
for FV = $55,255,000.

Step 3: Calculate MIRRA as follows:

Enter N = 4, PV = -25000000, PMT = 0, and FV = 55255000 to

solve for I = 21.93%.

Use 3 steps to calculate MIRRB @ k = 10%:

Step 1: Calculate the NPV of the uneven cash flow stream, so its FV
can then be calculated. With a financial calculator, enter
the cash flow stream into the cash flow registers, then
enter I = 10, and solve for NPV = $36,554,880.

Integrated Case: 10 - 19
 Step 2: Calculate the FV of the cash flow stream as follows:
Enter N = 4, I = 10, PV = -36554880, and PMT = 0 to solve
for FV = $53,520,000.

Step 3: Calculate MIRRB as follows:

Enter N = 4, PV = -25000000, PMT = 0, and FV = 53520000 to
solve for I = 20.96%.

According to the MIRR approach, if the 2 projects were mutually

exclusive, Project A would be chosen because it has the higher MIRR.
This is consistent with the NPV approach. Note: Because these two
projects are equal in size, we don’t need to worry about a conflict
between the MIRR and NPV decisions.

Integrated Case: 10 - 20