Saba Azhar MM113114 SECTION 1

ANSWERS TO THEORITICAL QUESTIONS

Q2. As the Pay Back Periods are 10 years, 10 years and 6years respectively for the infomercial, training video and combined project, there is no project which fulfills the criteria of 4 years Payback, hence no one is acceptable based on the criteria set by IEI. Q3. The pay back period of both projects is same the reason is that pay back period only considers that limit of cash flows where initial outlay is recovered. The time value of money concept in this case is missing in there is no other undiscounted technique to calculate the efficacy of both projects except ARR. but this measure is also weaker because it based on earning not on cash flows. Q 4. If we examine the pay back period it considers only one important assumption i.e. only consider that period of time where our initial investment recovered. It does not consider all cash flows of the company.

Q 5. a. b. c. Infomercial Project. Training Video Project. Combined Project. No. NPV is negative. No. NPV is negative. Yes NPV is positive.

Q6 Infomercial Project.

No because IRR < WACC. Also note that the project is slightly more risky than firms existing projects. It means the Discount rate has to be increased slightly for these projects. Training Video Project. No because IRR < WACC. Also note that the project is slightly more risky than firms existing projects. It means the Discount rate has to be increased slightly for these projects. Combined Project. Yes because IRR > WACC. Its IRR is 11% higher by 1% than WACC (10). It will cover the additional risk assumed. Q 7. IRR is not accurate measure. The evaluation must be substantiated by NPV method.

Q 8. NPV Method is superior to all because

(1) It account for all the cash flows. (2) Apply time value of money principle, (3) Conform to value additively principle. (4) Uses opportunity cost of capital for discounting the cash flows.

IRR is next best as (1) Discount cash flows (2) Takes all CFs into account. However its draw backs are that (1) Wrongly assumes that amount earned can be reinvested at project RR. (2) Violates value additively principle.

Payback period method is the worst of all these three Methods because it (1) Does not take all CFs under consideration, (2) Does not apply time value of money principle,

Q 9. In the present situation we used WACC as discount rate. If the risk of new project is substantially high, we would need to adjust discount rate for the risk (Risk Adjusted Discount Rate RADR). For selection of projects: we will select the project if its NPV => RADR. If use IRR then IRR=> RADR.

Q 10 a. b. NPV of all projects would decrease. IRR will not change.

c. Project Selection.Will select the project if its NPV => RADR. If use IRR then IRR=> RADR.