Question

Look at the cash flows for projects F and G given below.

Cash Flows($)
Project	C0			C1		C2		C3		C4		C5		C6		C7		C8		IRR (%)		NPV at 10%
F	(10,000	)		6,000		6,000		6,000		0		0		0		0		0		36.3		4,921
G	(10,000	)		3,000		3,000		3,000		3,000		3,000		3,000		3,000		3,000		25.0		6,005

The cost of capital was assumed to be 10%. Assume that the forecasted cash flows for projects of this type are overstated by 8% on average. That is, the forecast for each cash flow from each project should be reduced by 8%. But a lazy financial manager, unwilling to take the time to argue with the projects’ sponsors, instructs them to use a discount rate of 18%.

a. What are the projects’ true NPVs? (Do not round intermediate calculations. Round your answers to nearest dollar amount.)

b. What are the NPVs at the 18% discount rate? (Do not round intermediate calculations. Round your answers to nearest dollar amount.)

Answer 1

Solution :

a. The project's True NPV's are as follows :

Project F = $ 3,727

Project G = $ 4,737

Note :

Since the cash flows of the project had been overstated by 8 %, the same have been corrected as follows :

= Cash flow * ( 1 - 0.08 )

b. The NPV's of the project at discount rate of 18 % are as follows :

Project F = $ 3,046

Project G = $ 2,233

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.