Principle of Finance II 1-10 Questions

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1.  A firm has a $40 million capital budget limit. Five high IRR projects of about equal size are available that have initial investments totaling $30M. A sixth project has an IRR slightly lower than those of the first five, but requires a $16M investment. Several smaller projects are available with much lower IRR's. Discuss which projects should be done using capital rationing thinking.

2.  When retained earnings are exhausted, the MCC breaks upward. What happens if the firm continues to raise capital after that? Does the MCC remain flat or move further upward? In either case, why?

3.  Describe the difference between fixed and floating exchange rate systems.

Financial Management: Principles and Application - Caledonia, etc

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Prepare a response to the Caledonia Products Integrative Problem located near the end of Ch. 10 in Financial Management: Principles and Applications.

Formulate answers to questions 11a-11d, 12a–12e and 13a-13d

11. Caledonia is considering two investments with one-year lives. The more expensive of the two

is the better and will produce more savings. Assume these projects are mutually exclusive and that the required rate of return is 10 percent. Given the following after-tax net cash flows:

YEAR PROJECT A PROJECT B

0 −$195,000 −$1,200,000

1 240,000 1,650,000

a. Calculate the net present value.

b. Calculate the profitability index.

c. Calculate the internal rate of return.

d. If there is no capital-rationing constraint, which project should be selected? If there is a capital-rationing constraint, how should the decision be made?

12. Caledonia is considering two additional mutually exclusive projects. The cash flows associated with these projects are as follows:

YEAR PROJECT A PROJECT B

0 −$100,000 −$100,000

1 32,000 0

2 32,000 0

3 32,000 0

4 32,000 0

5 32,000 $200,000

The required rate of return on these projects is 11 percent.

a. What is each project’s payback period?

b. What is each project’s net present value?

c. What is each project’s internal rate of return?

d. What has caused the ranking conflict?

e. Which project should be accepted? Why?

13. The final two mutually exclusive projects that Caledonia is considering involve mutually exclusive pieces of machinery that perform the same task. The two alternatives available provide the following set of after-tax net cash flows:

YEAR EQUIPMENT A EQUIPMENT B

0 −$100,000 −$100,000

1 65,000 32,500

2 65,000 32,500

3 65,000 32,500

4 32,500

5 32,500

6 32,500

7 32,500

8 32,500

9 32,500

Equipment A has an expected life of three years, whereas equipment B has an expected life of

nine years. Assume a required rate of return of 14 percent.

a. Calculate each project’s payback period.

b. Calculate each project’s net present value.

c. Calculate each project’s internal rate of return.

d. Are these projects comparable?

e. Compare these projects using replacement chains and EAAs. Which project should be selected? Support your recommendation.