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Saba Azhar

MM113114

SECTION 1

ANSWERS TO THEORITICAL QUESTIONS

Q2. As the Pay Back Periods are 10 years, 10 years and 6years respectively for the infomercial,

training video and combined project, there is no project which fulfills the criteria of 4 years

Payback, hence no one is acceptable based on the criteria set by IEI.

Q3. The pay back period of both projects is same the reason is that pay back period only

considers that limit of cash flows where initial outlay is recovered. The time value of money

concept in this case is missing in there is no other undiscounted technique to calculate the

efficacy of both projects except ARR. but this measure is also weaker because it based on

earning not on cash flows.

Q 4. If we examine the pay back period it considers only one important assumption i.e. only

consider that period of time where our initial investment recovered. It does not consider all cash

flows of the company.

Q 5.

a. Infomercial Project. No. NPV is negative.

b. Training Video Project. No. NPV is negative.

c. Combined Project. Yes NPV is positive.

Q 6

Infomercial Project.

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No because IRR < WACC. Also note that the project is slightly more risky than firms

existing projects. It means the Discount rate has to be increased slightly for these

projects.

Training Video Project.No because IRR < WACC. Also note that the project is slightly more risky than firms

existing projects. It means the Discount rate has to be increased slightly for these

projects.

Combined Project.Yes because IRR > WACC. Its IRR is 11% higher by 1% than WACC (10). It will cover

the additional risk assumed.

Q 7.

IRRis not accurate measure. The evaluation must be substantiated by NPV method.

Q 8.

NPV Method is superior to all because

(1) It account for all the cash flows.

(2) Apply time value of money principle,

(3) Conform to value additively principle.

(4) Uses opportunity cost of capital for discounting the cash flows.

IRR is next best as

(1) Discount cash flows

(2) Takes all CFs into account.

However its draw backs are that

(1) Wrongly assumes that amount earned can be reinvested at project RR.

(2) Violates value additively principle.

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