Answers to Mini-Case Questions

1823 WordsFeb 6, 20138 Pages
( Answers to Mini-Case Questions BioCom Inc. This mini-case provides a review of the methodology and rationale associated with the various capital budgeting evaluation methods such as payback period, discounted payback period, NPV, IRR, MIRR, and PI. 1. Compute the payback period for each project. |Time of Cash Flow |Nano Test Tubes |Microsurgery Kit | |Investment |−$11,000.00 |−$11,000.00 | |Year 1 | 2,000.00 | 4,000.00 | |Year 2 | 3,000.00 | 4,000.00 | |Year 3…show more content…
The solutions can be found effortlessly with a financial calculator or a spreadsheet such as EXCEL. a. Explain the rationale behind the IRR method. By computing the highest discount rate at which a project will have a positive NPV, the IRR method is supposed to assure that the actual rate of return on an accepted project is higher than the required rate of return. b. State and explain the decision rule behind the IRR method. Assume a hurdle rate of 10%. If the IRR exceeds the required rate of return (10%), the project should be accepted. Otherwise, it should be rejected. c. Explain how the IRR method would be used to rank mutually exclusive projects. When choosing between projects with acceptable IRRs, the one with the highest IRR should be chosen. d. Comment on the advantages and shortcomings of this method. IRR uses all cash flows and incorporates the time value of money. When evaluating independent projects, IRR will always lead to the same decision as NPV. Because IRR assumes that cash flows will be reinvested at the internal rate of return, which is not always or even usually the case, it can rank mutually exclusive projects incorrectly. With certain patterns of cash flows, the IRR equation has more than one solution, which confuses the decision rule. IRR is slightly more
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