A firm has the following investment alternatives: Cash Inflows A B C Year 1 $1,1

Question

A firm has the following investment alternatives:

                                                           Cash Inflows

                                            A                    B                       C

Year 1                      $1,100     $3,600       —

        2                                1,100     —    —

        3                                1,100                   —                 $4,562

Each investment costs $3,000; investments B and C are mutuallyexclusive, and the firm's

cost of capital is 8 percent.



a. What is the net present value of each investment?



b. According to the net present values, which investment(s) shouldthe firm make? Why?



c. What is the internal rate of return on each investment?



d. According to the internal rates of return, which investment(s)should the firm make?

Why?



e. According to both the net present values and internal rates ofreturn, which investments

should the firm make?



f. If the firm could reinvest the $3,600 earned in year one frominvestment B at 10

percent, what effect would that information have on your answer topart e? Would the

answer be different if the rate were 14 percent?



g. If the firm's cost of capital had been 10 percent, what would beinvestment A's internal

rate of return?



h. The payback method of capital budgeting selects whichinvestment? why?(review chapter 19, if necessary.)

Explanation / Answer

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