Essentials of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
9th Edition
ISBN: 9781259277214
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Bradford D Jordan Professor
Publisher: McGraw-Hill Education
expand_more
expand_more
format_list_bulleted
Concept explainers
Question
Chapter 12, Problem 9CTCR
Summary Introduction
To discuss: Whether the companies should proceed with their investments in natural gas wells.
Introduction:
The cost of capital refers to the return that the investors expect on a particular investment. In other words, it refers to the compensation demanded by the investors for using their capital.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solutionStudents have asked these similar questions
A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose? (compare NPVs for projects)WACC: 6.75%Year 0 1 2 3 4 CFS -$1,025 $380 $380 $380 $380CFL -$2,150 $765 $765 $765 $765
A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose?
WACC: 3.00%
Year 0 1 2 3 4
CFS -$1,025 $380 $380 $380 $380
CFL -$2,150 $765 $765 $765 $765
Hint: NPV = PV inflows – Cost
IRR: Internal Rate of Return IRR is the discount rate that forces PV inflows = cost.
A. $272.51
B. $306.08
C. $377.26
D. $340.98
E. $240.19
PLEASE SHOW YOUR WORK USING BA II CALCULATOR. THANK YOU.
A tire manufacturing firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. What is the cost of capital at which the decision to take project L (or S) based on NPV will contradict the decision based on IRR method? Hint: Calculate the crossover rate and explain how the crossover rate would influence your decision to take project L or project S based on NPV vs. IRR? Show your excel work and thoroughly explain your answer. See cash flows below:
Year
0
1
2
3
4
Project L: CFL
-$2,050
$770
$780
$790
$795
Project S: CFS
-$4,300
$1,300
$1,510
$1,520
$1,530
Chapter 12 Solutions
Essentials of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 12.1 - What is the primary determinant of the cost of...Ch. 12.1 - What is the relationship between the required...Ch. 12.2 - Prob. 12.2ACQCh. 12.2 - Prob. 12.2BCQCh. 12.3 - Prob. 12.3ACQCh. 12.3 - Prob. 12.3BCQCh. 12.3 - Prob. 12.3CCQCh. 12.4 - Prob. 12.4ACQCh. 12.4 - Why do we multiply the cost of debt by (1 TC)...Ch. 12.4 - Under what conditions is it correct to use the...
Ch. 12.5 - Prob. 12.5ACQCh. 12.5 - Prob. 12.5BCQCh. 12.6 - Prob. 12.6ACQCh. 12.6 - Prob. 12.6BCQCh. 12 - Section 12.1What are the components used to...Ch. 12 - Prob. 12.2CCh. 12 - Prob. 12.3CCh. 12 - Prob. 12.4CCh. 12 - Section 12.5True or False: Projects should always...Ch. 12 - WACC. On the most basic level, if a firms WACC is...Ch. 12 - Prob. 2CTCRCh. 12 - Project Risk. If you can borrow all the money you...Ch. 12 - LO4 12.4WACC and Taxes. Why do we use an aftertax...Ch. 12 - DGM Cost of Equity Estimation. What are the...Ch. 12 - Prob. 6CTCRCh. 12 - Prob. 7CTCRCh. 12 - Prob. 8CTCRCh. 12 - Prob. 9CTCRCh. 12 - Prob. 10CTCRCh. 12 - Prob. 1QPCh. 12 - Calculating Cost of Equity. Halestorm Corporations...Ch. 12 - Calculating Cost of Equity. Stock in CDB...Ch. 12 - Estimating the DCF Growth Rate. Suppose Hornsby...Ch. 12 - Prob. 5QPCh. 12 - LO2 6Calculating Cost of Debt. ICU Window, Inc.,...Ch. 12 - LO2 7Calculating Cost of Debt. Jimmys Cricket Farm...Ch. 12 - Calculating Cost of Debt. For the firm in Problem...Ch. 12 - Calculating WACC. Bargeron Corporation has a...Ch. 12 - Prob. 10QPCh. 12 - Prob. 11QPCh. 12 - Book Value versus Market Value. Bonaime, Inc., has...Ch. 12 - Calculating the WACC. In Problem 12, suppose the...Ch. 12 - WACC. Clifford, Inc., has a target debtequity...Ch. 12 - Prob. 15QPCh. 12 - Finding the WACC. Hankins Corporation has 5.4...Ch. 12 - SML and WACC. An all-equity firm is considering...Ch. 12 - Calculating the WACC. You are given the following...Ch. 12 - Calculating Capital Structure Weights. Liu...Ch. 12 - Calculating the WACC. Gnomes R Us is considering a...Ch. 12 - Prob. 21QPCh. 12 - Calculating the Cost of Debt. Ying Import has...Ch. 12 - Prob. 23QPCh. 12 - Adjusted Cash Flow from Assets. Ward Corp. is...Ch. 12 - Adjusted Cash Flow from Assets. In the previous...Ch. 12 - Prob. 26QPCh. 12 - WACC and NPV. Photochronograph Corporation (PC)...Ch. 12 - Project Evaluation. This is a comprehensive...Ch. 12 - Prob. 1CCCh. 12 - Cost of Capital for Layton Motors You have...Ch. 12 - Prob. 3CCCh. 12 - Prob. 4CCCh. 12 - Prob. 5CC
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose? WACC: 6.75% 0 1 2 3 4 CFS -$1,025 $380 $380 $380 $380 CFL -$2,150 $765 $765 $765 $765arrow_forwardA firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose? WACC: 6.75% 0 1 2 3 4 CFS -$1,025 $380 $380 $380 $380 CFL -$2,150 $765 $765 $765 $765 Please explain and show calculations.arrow_forwardA firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose? WACC: 5.29 % 0 1 2 3 4 CFS -$ 1,036 $380 $380 $380 $380…arrow_forward
- I need solutions for questions d, e, f, g, h and i. Thanks d. Are this project’s cash flows likely to be positively or negatively correlated withreturns on Cory’s other projects and with the economy, and should this matter in youranalysis? Explain.e. Unrelated to the new product, Cory is analyzing two mutually exclusive machines thatwill upgrade its manufacturing plant. These machines are considered average-riskprojects, so management will evaluate them at the firm’s 10% WACC. Machine Xhas a life of 4 years, while Machine Y has a life of 2 years. The cost of each machineis $60,000; however, Machine X provides after-tax cash flows of $25,000 per year for4 years and Machine Y provides after-tax cash flows of $42,000 per year for 2 years. Themanufacturing plant is very successful, so the machines will be repurchased at the endof each machine’s useful life. In other words, the machines are “repeatable” projects.1. Using the replacement chain method, what is the NPV of the better machine?2.…arrow_forwardND Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates other methods. If the decision is made by choosing the project with the higher IRR, how much, if any, value will be forgone, i.e., what's the Profitability index? Discuss your results of these methods and make a recommendation on the projects to the CEO about which one to go for and why?arrow_forwardFinance Companies A and B are each considering an unanticipated new investment opportunity that will marginally increase the value of the company and will also increase the company’s level of diversication. Company A is unlevered, and company B has a capital structure of 50% debt. Assume that the shareholders control the company, which one of the following statements is correct. a) Since NPV of the investment is positive both company A and B will accept the project. b) Since the project only marginally increase company values but decreases return variance of the company’s assets both companies will reject the project. c) It is more obvious that Company B invests since for levered company the diversication benefits are more important. d) None of the given alternative.arrow_forward
- WSP Inc. is involved in a wide range of unrelated projects. The company will pursue any project that it thinks will create value for its stockholders. Consequently, the risk level of the company’s projects tends to vary a great deal from project to project. If WSP Inc. does not risk-adjust its discount rate for specific projects properly, which of the following is likely to occur over time? Check all that apply. The firm will increase in value. The firm’s overall risk level will increase. The firm could potentially reject projects that provide a higher rate of return than the company should require. When a project involves an entirely new product line, the firm may be able to obtain betas from to calculate a weighted average cost of capital (WACC) for its new product line. Consider the case of another company. Chrome Printing is evaluating two mutually exclusive projects. They both require a $1 million investment today and have expected NPVs of…arrow_forward“The stand-alone risk of an individual corporate project may be quite high, but viewed in the context of its effect on stockholders’ risk, the project’s true risk may be much lower." How does the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk?arrow_forwardND Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates other methods. If the decision is made by choosing the project with the higher IRR, how much, if any, value will be forgone, i.e., what's the NPV and IRR of the chosen project(s). What is the Payback period and discounted payback period?arrow_forward
- Tallant Technologies is considering two potential projects, X and Y. In assessing the projects' risks, the company estimated the beta of each project versus both the company's other assets and the stock market, and it also conducted thorough scenario and simulation analyses. This research produced the following data: Project X Project Y Expected NPV $500,000 $500,000 Standard deviation (sNPV) $200,000 $250,000 Project beta (vs. market) 1.4 0.8 Correlation of the project cash flows with cash flows from currently existing projects. Project X’s cash flows are not correlated with the cash flows from existing projects. Project Y’s cash flows are highly correlated with the cash flows from existing projects.Which of the following statements is CORRECT? Group of answer choices Project X has more corporate (or within-firm) risk than Project Y. Project X has less market risk than Project Y. Project X has more market risk than Project Y. Project…arrow_forwardLasik Vision Inc. recently analyzed the project whose cash flows are shown below. However, before Lasik decided toaccept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm'sWACC. The Fed's action did not affect the forecasted cash flows. By how much did the change in the WACC affect theproject's forecasted NPV? Note that a project's projected NPV can be negative, in which case it should be rejected.Old WACC: 8.00% New WACC: 11.25%Year 0 1 2 3Cash flows −$1,000 $410 $410 $410arrow_forwardExecutives at XYZ Corporation realize that they have too much liquid assets. They want to use this cash to buy a company that has decent returns to maximize their asset utilization. They find two companies they can buy, and want to decide if they should acquire company A or Company B. The expected returns from both companies depending on the state of the economy are shown in the table below. Each state of the economy is equally likely to happen. State of the economy Return on company A(%) Return on company B (%) Worse than expected 7.3% -4.7% Expected 11.5% 5.4% Better than expected 16.6% 24.3% Calculate the expected rate of return, and standard deviation of each company. [Note: you are supposed to show every step of your calculation and interpret the result.] Critically evaluate the importance of the standard deviation factor in comparing investments. [Note: remember to use Harvard referencing to reference your sources]arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Capital Budgeting Introduction & Calculations Step-by-Step -PV, FV, NPV, IRR, Payback, Simple R of R; Author: Accounting Step by Step;https://www.youtube.com/watch?v=hyBw-NnAkHY;License: Standard Youtube License