1. You are deciding between two mutually exclusive projects. Both require the same initial investment of $10 million. Project A will generate $2 million per year in perpetuity. Project B will generate $1.5 million in the first year and its revenues will increase at 2% per year for every year after that. a. Which investment has the higher IRR? b. If the cost of capital is 7%, which investment has the higher NPV? c. Which project should you choose? How can you adapt the IRR rule so that it results in the right decision? 2. The Borstal Company has to choose between two machines that do the same job but have different lives. The two machines have the following costs (expressed in real terms): a. Suppose you are Borstal's financial manager. If you had to buy one or the other machine and rent it to the production manager for that machine's economic life, what annual rental payment would you have to charge? Assume a 6 percent real discount rate and ignore taxes. b. Which machine should Borstal buy? c. Usually the rental payments you derived in part (a) are just hypothetical - a way of calculating and interpreting equivalent annual cost. Suppose you actually do buy one of the machines and rent it to the production manager. How much would you actually have to charge in each future year if there is steady 8 percent per year inflation? 3. You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant's report on your desk, and complains, "We owe these consultants $1 million for this report, and I am not sure their analysis makes sense. Before we spend the $25 million on the new equipment needed for this project, look it over and give me your opinion." You open the report and find the following estimates (in thousands of dollars) for the project: All of the estimates in the report seem correct. You note that the consultants used straight line depreciation for the new equipment that will be purchased today (year 0), which is what the accounting department recommended. The report concludes that because the project will increase earnings by $4.875 million per year for ten years, the project is worth $48.75 million. You think back to your halcyon days in finance class and realize there is more work to be done! First, you note that the consultants have not factored in the fact that the project will require $10 million in working capital upfront (year 0 ), which will be fully recovered in year 10 . Next, you see they have attributed $2 million of selling, general and administrative expenses to the project but you know that $1 million of this amount is overhead that will be incurred even if the project is not accepted. Finally, you know that accounting earnings are not the right thing to focus on! a. Given the available information, what are the free cash flows in years 0 through 10 that should be used to evaluate the proposed project? b. If the cost of capital for this project is 14%, what is your estimate of the value of the new project