CFA2 - Homework - Week 1

Name: Điều Phúc Thịnh
Student ID: B18H0077

Class: CFA2
Group: 2
Homework – Week 1
Question 1
A $2.2 million investment will result in the cash flows shown below:
Calculate the project’s net present value (NPV) using an 8% opportunity cost of capital. Show
your work.
Answer:
Question 2
A three-year investment requires an initial outlay of £1,000. It is expected to provide
three year- end cash flows of £200 plus a net salvage value of £700 at the end of three
years. Calculate its internal rate of return (IRR). Show your work.
Answer:
Question 3
Given the following cash flows for a capital project, calculate its payback period and
discounted payback period. Explain why the discounted payback is longer than the paypack.
Show your work. The required rate of return is 8 percent.
Answer
Đvt:1000
CF -50 15 15 20 10 5
Cumultive -50 -35 -20 0 10 5
CF
Discounted -50 13.88 12.86 15.88 7.35 3.4
CF
Cumulativ -50 -36.12 -23.26 -7.38 -0.03 3.54
e CF
20
Paypack period=2+ =3 year
20
0.03
Discounted PP=4+ =4.01 years
3.4
Question 4
Hermann Corporation is considering an investment of €375 million with expected after-tax
cash inflows of €115 million per year for seven years and an additional after-tax salvage
value of €50 million in Year 7. The required rate of return is 10 percent. What is the
investment’s PI? Show your work.
Answer
YEAR 0 1 2 3 4 5 6 7
-375 115 115 115 115 115 115 50
115 115 50
NPV =375+ + + …+ =185.81
1+ 8 % (1+ 8 % )2 1+ 8 %
NPV 185.81
PI =1+ =1+ =1.49
CF 0 375
Question 5
Projects 1 and 2 have similar outlays, although the patterns of future cash flows are different.
The cash flows for the two projects are shown below. For both projects, the required rate of
return is 10 percent. The two projects are mutually exclusive. What is the appropriate
investment decision? Justify your answer.
Answer
r=10%
20 20 20 20
NPV 1=−50+ + + + =¿ NPV =13.397
1+r (1+ r ) ( 1+ r ) ( 1+ r )4
2 3
0 0 0 100
NPV 2=−50+ + + + =18.301
1+r ( 1+ r ) ( 1+ r ) ( 1+r )4
2 3
 Choose project 2 because NPV1 < NPV2
Question 6
Consider the two projects below. The cash flows as well as the NPV and IRR for the two projects
are given. For both projects, the required rate of return is 10 percent.
A. A rate between 0.00 percent and 10.00 percent.

B. A rate between 10.00 percent and 15.02 percent.
C. A rate between 15.02 percent and 16.37 percent.
Answer:
36 36 36 36
NPV=0=−100+ 1+ IRR + + + =¿ IRR=16.37 %
( 1+ IRR ) ( 1+ IRR ) ( 1+ IRR ) 4
2 3
Question 7: With regard to net present value (NPV) profiles, the point at which a profile crosses the
vertical axis is best described as:
A. the point at which two projects have the same NPV.
B. the sum of the undiscounted cash flows from a project.
C. a project’s internal rate of return when the project’s NPV is equal to zero.
Answer:

The vertical axis represents a discount rate of zero. The point where the profile crosses the
vertical axis is simply the sum of the cash flows.
Question 8: With regard to the net present value (NPV) profiles of two projects, the crossover rate
is best described as the discount rate at which:
A. two projects have the same NPV.
B. two projects have the same internal rate of return.
C. a project’s NPV changes from positive to negative.
Answer:
A. two projects have the same NPV.
The crossover rate is the discount rate at which the NPV profiles for two projects cross; it is the
only point where the NPVs of the projects are the same.
Question 9: With regard to net present value (NPV) profiles, the point at which a profile crosses the
vertical axis is best described as:
Answer:
The vertical axis represents a discount rate of zero. The point where the profile crosses the vertical
axis is simply the sum of the cash flows.
Question 10: With regard to net present value (NPV) profiles, the point at which a profile crosses
the horizontal axis is best described as:
Answer:
The horizontal axis represents an NPV of zero. By definition, the project's IRR equals an NPV of
zero.
Question 11: With regard to capital budgeting, an appropriate estimate of the incremental cash
flows from a project is least likely to include:
A. externalities.
B. interest costs.
C. opportunity costs.
Answer:
B. interest costs
Costs to finance the project are taken into account when the cash flows are discounted at the
appropriate cost of capital; including interest costs in the cash flows would result in double-
counting the cost of debt
Question 12: Discuss advantages and disadvantages of the following investment decision criteria:
Criteria Advantages Disadvantages

NPV Direct measures of the Does not consider of project
expected increase in firm value
IRR Measure profitanlity as a May producing ranking
percentage different from those NPV
method project may have
multiple or IRR
Paypack Good measuces of liquidity Ignore time value of money
Ignore cash flow beyond payback
period
Poor measure of projitability
Discounted payback
PI

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Name: Điều Phúc Thịnh

Student ID: B18H0077

 Choose project 2 because NPV1 < NPV2

A. A rate between 0.00 percent and 10.00 percent.

B. the sum of the undiscounted cash flows from a project.

Criteria Advantages Disadvantages

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