Question

Froogle Enterprises is evaluating an unusual investment project. What makes the project unusual is the stream of cash inflows and outflows shown in the following​ table:

Year 1 $210,000

Year 2 -$966,000

Year 3 $1,661,100

Year 4 -$1,265,460

Year 5 $360,360

.

1.  Why is it difficult to calculate the payback period for this​ project?

2.  Calculate the​ investment's net present value at each of the following discount​ rates: 0%, 5​%, 10​%, 15​%, 20%, 25%, 30%​, 35%.

3.  What does your answer to part b tell you about this ​project's IRR​?

4.  Should Froogle invest in this project if its cost of capital is 5%? What if the cost of capital is 15%?

5.  In​ general, when faced with a project like​ this, how should a firm decide whether to invest in the project or reject​ it?

1.  Why is it difficult to calculate the payback period for this​ project? ​ (Select the best answer​ below.)

A.The huge amount of cash outflow in year 3 makes the calculation difficult.

B.The oscillating cash flows make it difficult to compute the payback period.

C.The short life of the project makes it difficult to compute the payback period.

D.It is unreal for a project to have a cash inflow as an initial investment.

2. If the discount rate is 0%, the​ investment's NPV is . ​$______(Round to two decimal​ places.)

If the discount rate is 5​%, the​ investment's NPV is . $________​(Round to two decimal​ places.)

If the discount rate is 10%, the​ investment's NPV is $________(Round to two decimal​ places.)

If the discount rate is 15​%, the​ investment's NPV is ​$________(Round to two decimal​ places.)

If the discount rate is 20%, the​ investment's NPV is $________(Round to two decimal​ places.)

If the discount rate is 25%, the​ investment's NPV is $________​(Round to two decimal​ places.)

If the discount rate is 30%, the​ investment's NPV is ​$________​(Round to two decimal​ places.)

If the discount rate is 35%, the​ investment's NPV is $________(Round to two decimal​ places.)

3.  What does your answer to part b tell you about this ​project's ​IRR?  ​(Select the best answer​ below.)

A. There are multiple IRRs for this project.

B. There are infinite IRRs for this project.

C. There is no IRR for such cash flows.

D. There is only one IRR for this project.

4.  Should Froogle invest in this project if its cost of capital is 5​%?

A. Yes

B. No

Should Froogle invest in this project if its cost of capital is 15%?

A.Yes

B.No

5.  In​ general, when faced with a project like​ this, how should a firm decide whether to invest in the project or reject​ it?  ​(Select the best answer​ below.)

A.It is best to use the IRR method.

B.It is best to use the payback period method.

C.It is best to use the NPV method.

D.None of the methods is suitable.

Answer 1

Answer 1) Correct option is (b) The oscillating cashflows will make it very difficult for calculating the payback period.

Answer 2)

NPV is given by:

Also,

IRR is the discount rate at which NPV = 0

We can use excel function "IRR" for the same.

Using this and discounted cash flows:

Hence,

using these formula:

Similarly calculating for other discount rates, we can derive the following table:

Discount Rate	NPV	IRR
0%	0	10%
5%	-15.43	10%
10%	0	10%
15%	5.87	10%
20%	0	10%
25%	-6.45	10%
30%	0	10%
35%	30.73	10%

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Answer 3)

From the above calculation we can see that project's IRR is always 10%. Hence correct option is (D) there is only one IRR of the project

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Answer 4)

At cost of capital = 5%

This means company is getting money @5% and minimum this much return should we get from the project.

However, from the table we can see that for 5% discount rate, we have NPV as negative. Hence, company should not invest is cost of capital is 5%.

At cost of capital = 15%

This means company is getting money @15% and minimum this much return should we get from the project.

However, from the table we can see that for 15% discount rate, we have NPV as positive. But, IRR < WACC (discount rate). hence this project should not be accepted

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