Just One, Inc., Has Two Mutually Exclusive Investment Projects, P and Q, Shown Below. Suppose the Market Interest Rate Is 10 Percent.
P 3–4: Just One, Inc.
Just One, Inc., has two mutually exclusive investment projects, P and Q, shown below. Suppose the market interest rate is 10 percent.
The ranking of projects differs, depending on the use of IRR or NPV measures. Which project should be selected? Why is the IRR ranking misleading?
Using the IRR method will result in project Q being selected over P due to its higher rate of return. Using the NPV method would result in choosing project P because of its higher NPV. When there are mutually exclusive project, NPV method would be preferred.
IRR is misleading because it ignores the absolute amount from the wealth of shareholders which may be increased when the project would be undertaken. It may also be misleading because IRR makes an assumption that interim cash flows are being reinvested at the same equal return rate.
P 3–10: Mr. Jones’s Retirement
Mr. Jones intends to retire in 20 years at the age of 65. As yet he has not provided for retirement in-come, and he wants to set up a periodic savings plan to do this. If he makes equal annual payments into a savings account that pays 4 percent interest per year, how large must his payments be to ensure that after retirement he will be able to draw $30,000 per year from this account until he is 80?
We first compute the present value at the end of the year when he is 65, when he will be required to make 15 annual payments of $30,000.
PMT | -$30,000 | N | 15 | Rate | 4.00% | | | PV | $333,551.62 |
Then we compute the amount that needs to be added every for 20 years to make future the future value of $333,551.62.
FV | -$333551.62 | N | 20 | Rate | 4.00% | | | PMT | $11,201.25 |
So, he will have to deposit $11,201.25 every year.
P 3–19: House Mortgage
You have just purchased a house and have obtained a 30-year, $200,000 mortgage with an interest rate of 10 percent.
Required:
a. What is your annual payment?
b. Assuming you bought the house on
Just One, Inc., has two mutually exclusive investment projects, P and Q, shown below. Suppose the market interest rate is 10 percent.
The ranking of projects differs, depending on the use of IRR or NPV measures. Which project should be selected? Why is the IRR ranking misleading?
Using the IRR method will result in project Q being selected over P due to its higher rate of return. Using the NPV method would result in choosing project P because of its higher NPV. When there are mutually exclusive project, NPV method would be preferred.
IRR is misleading because it ignores the absolute amount from the wealth of shareholders which may be increased when the project would be undertaken. It may also be misleading because IRR makes an assumption that interim cash flows are being reinvested at the same equal return rate.
P 3–10: Mr. Jones’s Retirement
Mr. Jones intends to retire in 20 years at the age of 65. As yet he has not provided for retirement in-come, and he wants to set up a periodic savings plan to do this. If he makes equal annual payments into a savings account that pays 4 percent interest per year, how large must his payments be to ensure that after retirement he will be able to draw $30,000 per year from this account until he is 80?
We first compute the present value at the end of the year when he is 65, when he will be required to make 15 annual payments of $30,000.
PMT | -$30,000 | N | 15 | Rate | 4.00% | | | PV | $333,551.62 |
Then we compute the amount that needs to be added every for 20 years to make future the future value of $333,551.62.
FV | -$333551.62 | N | 20 | Rate | 4.00% | | | PMT | $11,201.25 |
So, he will have to deposit $11,201.25 every year.
P 3–19: House Mortgage
You have just purchased a house and have obtained a 30-year, $200,000 mortgage with an interest rate of 10 percent.
Required:
a. What is your annual payment?
b. Assuming you bought the house on