Question

Frieda Inc. is considering a capital expansion project. The initial investment of undertaking this project is $105,500. This expansion project will last for five years. The net operating cash flows from the expansion project at the end of year 1, 2, 3, 4 and 5 are estimated to be $22,500, $25,800, $33,000, $45,936 and $58,500 respectively. Frieda has weighted average cost of capital equal to 24%.

What is the NPV of undertaking this expansion project? That is, what is the NPV if the weighted average cost of capital is used as the discount rate?

Question options:

-$15,183.60

-$13,882.85

$1,817.34

$1,445.94

Based on the NPV obtained above, shall Frieda undertake the expansion project?

Question options:

No, because NPV>0.

No, because NPV<0.

Yes, because NPV<0.

Yes, because NPV>0.

Based on the Profitability Index (PI) obtained above, shall Frieda undertake the expansion project?

Question options:

No, because PI <1.

No, because PI <0.

Yes, because PI >0.

Yes, because PI >1.

Based on IRR obtained above, shall Frieda undertake this project? Assuming the weighted average cost of capital is the appropriate discount rate for the capital budgeting problems considered.

Question options:

Yes, IRR > Weighted Average Cost of Capital.

No, IRR > Weighted Average Cost of Capital.

No, IRR < Weighted Average Cost of Capital.

Yes, IRR > 0.

What is the modified internal rate of return if Frieda undertakes this project. Assuming that the positive cash inflow from undertaking this project will be reinvested at the weighted average cost of capital.

Question options:

18.99%

20.55%

24%

19.17%

Answer 1

1) Ans: -$13,882.85

Statement showing NPV

Year	Cash flow	PVIF @ 24%	PV
	A	B	C = A x B
1	22500	0.8065	18145.16
2	25800	0.6504	16779.40
3	33000	0.5245	17308.08
4	45936	0.4230	19429.72
5	58500	0.3411	19954.80
Total of PV of cash inflow	91617.16
Less : Initial investment	105500
NPV	-13882.85

Thus NPV = -13882.85 $

2) Ans : No, because NPV<0

Since NPV is negative , project should not be selected

3) Ans : No, because PI <1.

PI = PV of cash inflow/PV of cash out flow

= 91617.16/105500

= 0.87

Since PI is less than 1, project should not be selected

4) Ans : No, IRR < Weighted Average Cost of Capital

IRR is rate at which NPV is 0

Assume r = 19%

Statement showing NPV

Year	Cash flow	PVIF @ 19%	PV
	A	B	C = A x B
1	22500	0.8403	18907.56
2	25800	0.7062	18219.05
3	33000	0.5934	19582.72
4	45936	0.4987	22906.85
5	58500	0.4190	24514.39
Total of PV of cash inflow	104130.57
Less : Initial investment	105500
NPV	-1369.43

Assume r = 18%

Statement showing NPV

Year	Cash flow	PVIF @ 18%	PV
	A	B	C = A x B
1	22500	0.8475	19067.80
2	25800	0.7182	18529.16
3	33000	0.6086	20084.82
4	45936	0.5158	23693.28
5	58500	0.4371	25570.89
Total of PV of cash inflow	106945.94
Less : Initial investment	105500
NPV	1445.94

Using Interpolation we can find IRR

R	NPV
18%	1445.94
19%	-1369.43
1%	2815.37
?	1445.94

= 1445.94/2815.37

= 0.51

Thus IRR = 18% + 0.51% = 18.51%

Since IRR < Weighted Average Cost of Capital , project should not be selected

5) Ans : 20.55%

Statement showing Future value of +ve cash flow

Year	Cash flow	FVIF @ 24%	FV
	A	B	C = A x B
1	22500	2.3642	53194.81
2	25800	1.9066	49190.90
3	33000	1.5376	50740.80
4	45936	1.2400	56960.64
5	58500	1.0000	58500.00
Total of FV of cash inflow	268587.15

MIRR = [FV of +ve cash flow / PV of -ve cash flow]^1/n - 1

= [268587.15 / 105500]^1/5 - 1

= 2.5458^0.2 - 1

= 1.2055 - 1

= 0.2055

i.e 20.55 %