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¶ … NPV profiles for Franchises L. and S. At what discount rate do the profiles cross?
NPV
Due to the way that the revenues vary, they actually cross at a couple different points.
Look at your NPV profile graph without referring to the actual NPVs and IRRs. Which franchise or franchises should be accepted if they are independent? Mutually exclusive? Explain. Are your answers correct at any cost of capital less than 23.6%?
NPV
IRR
What is the underlying cause of ranking conflicts between NPV and IRR?
Because the NPV value reflects the cost of capital and the IRR does not.
g. Define the term modified IRR (MIRR). Find the MIRRs for Franchises L. and S.
MIRR considers the interest that could be potentially generated by the revenues, along with the revenues themselves.
0
($100)
($100)
NPV
($7.50)
$0.58
IRR
18%
24%
MIRR
19%
23%
h. What does the profitability index (PI) measure? What are the PI's for Franchises S. and L?
Answer:
It's the PV divided by the initial investment. -.075 & .058 respectively.
i. 1. What is the payback period? Find the paybacks for Franchises L. and S.
Answer: L. pays back in year 2, while S. is in year 3.
i. 2. What is the rationale for the payback method? According to the payback criterion, which franchise or franchises should be accepted if the firm's maximum acceptable payback is 2 years, and if Franchises L. and S. are independent? If they are mutually exclusive?
Answer:
S should be selected and L. should not be.
i. 3. What is the difference between the regular and discounted payback periods?
Answer:
The discounted payback period factors in the time value of money, while the regular period does not.
i. 4. What is the main disadvantage of discounted payback? Is the payback method of any real usefulness in capital budgeting decisions?
Answer:
The disadvantage is that is it based upon expected rates of return which can be subjective. However, such measures can be useful for many reasons, especially for comparing projects such as these.
NPV vs. IRR Discount rate 0%, NPV =$670,000 Discount rate 2%, NPV=$614,400 Discount rate 6%, NPV=$514,820 Discount rate 11% NPV= $409,000 Capital Cost 5%, Modified IRR= 45.6% Upon plotting these points on a chart an obvious relationship is modeled. The lower the discount rate the higher the NPV appears to manifest. The curve crosses the x axis at a discount rate of .03%. Rate at 1%, NPV=$65,358 Rate at 4%, NPV= $7,593 Rate at 10%, NPV= -$91,776 Rate at 18%,
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