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Question
arks Window Help courses.aplia.com YouTube slist Last Tuesday, Fuzzy Button Clothing Company lost a portion of its planning and financial data when both its main and its backup servers crashed. The company's CFO remembers that the internal rate of return (IRR) of Project Gamma is 11.3%, but he can't recall how much Fuzzy Button originally invested in the project nor the project's net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Gamma. They are: Year Cash Flow Year1 $1,800,000 Year 2 $3,375,000 Year 3 $3,375,000 Year 4 $3,375,000 The CFO has asked you to compute Project Gamma's initial investment using the information currently available to you. He has offered the following suggestions and observations: . A project's IRR represents the return the project would generate when its NPV is zero or the discounted value of its cash inflows equals the discounted value of its cash outflows-when the cash flows are discounted using the project's IRR. The level of risk exhibited by Project Gamma is the same as that exhibited by the company's average project, which means that Project Gamma's net cash flows can be discounted using Fuzzy Button's 8% WACC. Given the data and hints, Project Gamma's initial investment is (rounded to the nearest whole dollar) , and its NPV is $10,404,037 $9,296,809 $9,073,515 $8,988,943 A project's IRR will if the project's cash inflows increase, ana everything else is unaffected lash Player MAC 29,0,0,113 Q2 3.34.1 2004-2016 Apla, A rights reserved. ? 2013 Cengage Learning except as noted. All rights reserved Save & Co MacBook Pro
Explanation / Answer
Answer a.
Cash Flows:
Year 1 = $1,800,000
Year 2 = $3,375,000
Year 3 = $3,375,000
Year 4 = $3,375,000
IRR = 11.30%
Initial Investment = PV of Future Cash Flows at IRR
Initial Investment = $1,800,000/1.1130 + $3,375,000/1.1130^2 + $3,375,000/1.1130^3 + $3,375,000/1.1130^4
Initial Investment = $8,988,943
So, initial investment is $8,988,943
Answer b.
Cash Flows:
Year 0 = -$8,988,943
Year 1 = $1,800,000
Year 2 = $3,375,000
Year 3 = $3,375,000
Year 4 = $3,375,000
WACC = 8%
NPV = -$8,988,943 + $1,800,000/1.08 + $3,375,000/1.08^2 + $3,375,000/1.08^3 + $3,375,000/1.08^4
NPV = $731,152
So, NPV of this project is $731,152
Answer c.
A project’s IRR will increase if the project’s cash inflows increase, and everything else is unaffected.
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