FIN 306 NPV MID TERM EXAM|COMPLETE SOLUTION|
GRADED A+| LATEST 2026 UPDATE
Review for midterm exam
Cost of Capital and Capital Budgeting
Capital Budgeting
This topic and cost of capital as we will see go together. In order to calculate the Net Present
Value (NPV) of a project we will need the cost of capital to plug into the NPV equation. But I get
ahead of myself – let’s start at the beginning.
In this chapter I am concerned with the three major ways of deciding whether or not a
company should do a costly project: simple payback, net present value (NPV) and the internal
rate of return (IRR). Each has pros and cons and often a company will use all three, starting
with payback (the simplest and fastest to calculate) and if the project passes that test, the
company will go on to the more sophisticated models, NPV and IRR. Why both NPV & IRR? I’ll
discuss this more in a bit, but for now: NPV gives a $ answer, whereas IRR gives a % answer.
Often management will want to know both.
Payback:
You are considering two machines, A & B. They both do the same job and they are “mutually
exclusive”. THIS IS IMPORTANT! (Your text has a good discussion of this by the way.) Mutually
exclusive projects means that you will do ONE not both regardless of how nice both are! Why?
Because you can only use one. If you need one new conveyor system you might look at several,
but no matter how nice they all are – you only need one. OR: you are considering three
manufacturing projects. You have enough floor space in the plant to house one and only one.
All three projects would be profitable, but since you only have room for one – you pick project
“A” and that automatically eliminates all other projects.
This (mutually exclusive) concept is the opposite of “independent” projects. With independent
projects accepting one has no effect on considering the others. You will do as many of these
1
, independent projects as possible. By that I mean , all projects that pass your screening
(payback, NPV or IRR).
2
GRADED A+| LATEST 2026 UPDATE
Review for midterm exam
Cost of Capital and Capital Budgeting
Capital Budgeting
This topic and cost of capital as we will see go together. In order to calculate the Net Present
Value (NPV) of a project we will need the cost of capital to plug into the NPV equation. But I get
ahead of myself – let’s start at the beginning.
In this chapter I am concerned with the three major ways of deciding whether or not a
company should do a costly project: simple payback, net present value (NPV) and the internal
rate of return (IRR). Each has pros and cons and often a company will use all three, starting
with payback (the simplest and fastest to calculate) and if the project passes that test, the
company will go on to the more sophisticated models, NPV and IRR. Why both NPV & IRR? I’ll
discuss this more in a bit, but for now: NPV gives a $ answer, whereas IRR gives a % answer.
Often management will want to know both.
Payback:
You are considering two machines, A & B. They both do the same job and they are “mutually
exclusive”. THIS IS IMPORTANT! (Your text has a good discussion of this by the way.) Mutually
exclusive projects means that you will do ONE not both regardless of how nice both are! Why?
Because you can only use one. If you need one new conveyor system you might look at several,
but no matter how nice they all are – you only need one. OR: you are considering three
manufacturing projects. You have enough floor space in the plant to house one and only one.
All three projects would be profitable, but since you only have room for one – you pick project
“A” and that automatically eliminates all other projects.
This (mutually exclusive) concept is the opposite of “independent” projects. With independent
projects accepting one has no effect on considering the others. You will do as many of these
1
, independent projects as possible. By that I mean , all projects that pass your screening
(payback, NPV or IRR).
2
