1. You are considering two mutually exclusive projects: projects A and project B. The initial cash outlay (cost) associated with project A is $60,000, whereas the initial cash outlay associated with project B is $ 80,000. The required rate of return on both projects is 10 percent. The expected annual free cash inflows from each project are as follows:
Year
Project A
Project B
0
– 60,000
-80,000
1
13,000
15,000
2
13,000
15,000
3
13,000
15,000
4
13,000
15,000
5
13,000
15,000
6
13,000
15,000
A. Calculate the payback period. Which project should be accepted under the payback rule?
B. Calculate the NPV and the IRR for each project and; (i) indicate which project should be accepted, if mutually exclusive; (ii) Explain in detail why you selected or rejected the project/s; (iii). What are the implications for the firm if you selected the wrong project?
You must show the formula/s you used to arrive at your answers.
C. When comparing two mutually exclusive projects, (i) do you think the short –term project will be ranked higher using the NPV criterion if this project cost of capital is higher than the other project? (ii) Would the other long-term project be ranked higher under the NPV criterion (better) if its cost of capital is much lower? (iii) Would changes in the cost of capital ever cause a change in the IRR ranking of two such projects. Why or why not?
2. Jam inc stock has a beta of 0.9. The risk free rate is 5% and the expected return on the market is 11%. What is the expected rate of return on this stock.?
3. If you require 16% rate of return on a stock given a risk free rate of 4% and the expected return on the market of 12%, what would be the beta of the stock you should buy?
