Corporate Finance MCQ - Corporate Finance Section 1

56 Alpha Corporation is considering investing €500 million with expected aftertax cash inflows of €110 million per year for six consecutive years. The required rate of return is 8 percent. The project’s payback period and discounted payback period, respectively, are closest to:

Year	0	1	2	3	4	5	6
Cash flow	(500)	110	110	110	110	110	110
umulative cash flow	(500)	(390)	(280)	(170)	(60)	50	160

The payback is between 4 and 5 years. The payback period is 4 years plus
60/110 = 0.55 of the fifth year cash flow, or 4.55 years.

Year	0	1	2	3	4	5	6
Cash flow	(500)	110	110	110	110	110	110
Discounted cash flow	(500)	101.85	94.31	87.32	80.85	74.86	69.32
Cumulative DCF	(500)	(398.15)	(303.84)	(216.52)	(135.67)	(60.81)	(8.51)

The discounted payback is between 5 and 6 years. The discounted payback period is 5 years plus 60.81/69.32 = 0.88 of the sixth year cash flow, or 5.88 years.

57 A perpetual after-tax cash flow stream of $2,000 is created by an investment of $15,000. The required rate of return is 8 percent. The investment’s profitability index is closest to:

The present value of future cash flows is PV = 2,000/0.08 = 25,000. The profitability index is PI = PV / Investment = 25,000 / 15,000 = 1.67.

58 Digital Design Corporation is considering an investment of £400 million with expected after-tax cash inflows of £100 million per year for five years and an additional after-tax salvage value of £50 million in Year 5. The required rate of return is 7.5 percent. What is the investment’s PI?

Using the calculator: CF0 = - 400, C01 = 100, F01 = 4, C02 = 150, F02 = 1, I = 7.5, CPT NPV. NPV = 39.41. PI = 1 + (39.41/400) = 1.098 = 1.1 approx.

59 At which point the net present value profiles of two mutually exclusive projects with normal cash flows are most likely to intersect the horizontal axis?

For a project with normal cash flows, the NPV profile intersects the horizontal axis at the point where the discount rate is equal to the IRR. The crossover rate is the discount rate at which the NPVs of the projects are equal. While it is possible that the crossover rate is equal to each project’s IRR, it is not a likely event. The IRR for both projects being the firm’s WACC will only arise when both projects have a NPV = 0.

60 Alpha Corporation is considering investing €500 million with expected aftertax cash inflows of €110 million per year for six consecutive years. The required rate of return is 8 percent. The project’s NPV and IRR are closest to:

	NPV	IRR
A	€7 million	8.6%
B	€9 million	8.6%
C	€11 million	5.9%

Enter the following values in a financial calculator to determine NPV and IRR. CF0 = -500, C01 = 110, F01 = 6, I = 8, CPT NPV. NPV = 8.52 million euro. CPT IRR. IRR = 8.56 per cent.