Question 13-1

Project K has a cost of $52,125, its expected net cash inflows are $12,000 per year for 8 years, and its cost of capital
is 12 percent. (Hint: Begin by constructing a time line.)

a. What is the project’s payback period (to the closest year)?

b. What is the project’s NPV?

Solution:

Initial Cost = 52,125

Inflows = 12,000 / year for next 8 years

Cost of capital, k =12%

Since inflow per year is same: Payback Period = Initial Investment / Cash flow per year

Payback Period = 52125/12000 = 4.34 years ~ 4 years

NPV = 8000/(1+i) + 8000(1+i)2+ 8000(1+i)3+ 8000/(1+i)4 + 8000(1+i)5+ 8000(1+i)6+ 8000/(1+i)7 + 8000/(1+i)8 - 52125

NPV = 10714 + 9566 + 8541 + 7626 + 6809 + 6079 + 5428 + 4846 - 52125

NPV = $7486.7

Question 13-6

Your division is considering two investment projects, each of which requires an up-front expenditure of $15 million.
You estimate that the investments will produce the following after-tax cash flows

What are the two projects’ net present values, assuming the cost of capital is 10 percent? 5 percent? 15 percent?

Solution:
Question 13-7

Northwest Utility Corporation has a cost of capital of 11.5 percent, and it has a projects with the following net cash
flows:

What is the project’s NPV?

Solution:

NPV = 235/(1+0.115) - 65/(1+0.115)2 + 300/(1+0.115)3 - 200

NPV = 175

Question 13-8

Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in
this year’s capital budget. The projects are independent. The cash outlay for the truck is $17,100 and that for the
pulley system is $22,430. The firm’s cost of capital is 14%. After-tax cash flows, including depreciation, are as follows:
Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct accept–reject decision for each.

Solution:

NPV Truck = 5100/1.14 + 5100/1.142 +5100/1.143 +5100/1.144 +5100/1.145 - 17100

NPV Truck = $409

Changing k = 13% in above equation: NPV Truck = 838$

Changing k = 16% in above equation: NPV Truck = -401$

Changing k = 15% in above equation: NPV Truck = -$4 ~ 0

The IRR For Truck is 15%

NPV Pulley = 7500/1.14 + 7500/1.142 +7500/1.143 +7500/1.144 +7500/1.145 - 22430

NPV Pulley = $3318

Changing k = 15% in above equation: NPV Pulley = 2711$

Changing k = 17% in above equation: NPV Pulley = 1565$

Changing k = 19% in above equation: NPV Pulley = 502$

Changing k = 20% in above equation: NPV Pulley = 0

The IRR For Pulley is 20%

Projects are independant and both have positive NPV as well as IRR above required cost of capital so both can be
selected

Question 13-9

Davis Industries must choose between a gas- powered and an electric-Powered forklift truck for moving materials in
its factory. Since both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive
investments.) The electric-powered truck will cost more, but it will be less expensive to operate; it will cost $22,000,
wheras the gas-powered truck will cost $17,500. The cost of capital that applies to both investments is 12%. The life
for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered
truck will be$6,290 per year and those for the gas-powered truck will be $5,000 per year. Annual net cash flows
include depreciation expenses. Calculate the NPV and IRR for each type of truck, and decide which to recommend.

Solution:

NPV Electric Powered = 6290/1.12 + 6290/1.122 +6290/1.123 +6290/1.124 +6290/1.125 + 6290/1.126 - 22000

NPV Electric Powered = $3861

Changing k = 15% in above equation: NPV Electric Powered = 1804$

Changing k = 18% in above equation: NPV Electric Powered = 0

The IRR for Electric Powered Fork Lifter is 18%

NPV Gas Powered = 5000/1.12 + 5000/1.122 +5000/1.123 +5000/1.124 +5000/1.125 + 5000/1.126 - 17500

NPV Gas Powered = $3057

Changing k = 15% in above equation: NPV Gas Powered = 1422$

Changing k = 18% in above equation: NPV Gas Powered = -12 ~ 0

The IRR of Gas Powered Fork Lifter is 18%

Since IRR is same, the selection should be made based on high NPV project which is Electric powered Fork Lifter

Question 13-10

Project S has a cost of $10,000 and is expected to produce benefits (cash flows) of $3,000 per year for 5 years.
Project L costs $25,000 and is expected to produce cash flows of $7,400 per year for 5 years.

a. Calculate the two projects' NPVs, assuming a cost of capital of 12%.

b. Which project would be selected, assuming they are mutually exclusive?

c. Calculate the two projects' IRRs.

Solution:

NPV Project S = 3000(1-1.12^-5)/0.12 - 10000 = $814

Changing k = 15% in above equation: NPV Project S = 56$

Changing k = 15.25% in above equation: NPV Project S = -3 ~ 0

The IRR of Project S is 15.25%

NPV Project L = 74000(1-1.12^-5)/0.12 - 25000 = $1675

Changing k = 15% in above equation: NPV Project L = -194$

Changing k = 14.7% in above equation: NPV Project L = -17 ~ 0

The IRR of Project S is 14.7%

Using NPV Method, Project L should be selected

Using IRR% Method, Project S should be selected

Actually we should prefer NPV method and select Project L

Question 13-11

The Costa Rican Coffee Company is evaluating the within-plant distribution system for its new roasting, grinding, and
packing plant. The two alternatives are (1) a conveyor system with a high initial cost but low annual operating costs
and (2) several forklift trucks, which cost less but have considerably higher operating costs. The decision to construct
the plant has already been made, and the choice here will have no effect on the overall revenues of the project. The
cost of capital for the plant is 9 percent, and the projects’ expected net costs are listed below
 a. What is the IRR of each alternative?
b. What are the present value of costs of each alternative? Which method should be chosen?

Solution:

NPV Conveyor = -66000(1-1.09^-5)/0.09 - 300000 = -$556,716$

NPV Forklift = -96000(1-1.09^-5)/0.09 - 120000 = -493407$

IRR can't be calculated with only negative cash flows.

Using NPV Method, Forklift should be selected

Question 13-13

A company is analyzing two mutually exclusive projects, S and L, with the following cash flows:

The company’s cost of capital is 10 percent, and it can get an unlimited amount of capital at that cost. What is the
regular IRR of the better project? (Hint: Note that the better project may or may not be the one with higher IRR.)

Solution:

NPV Project S = 900/(1+0.1) - 250/(1+0.1)2 + 10/(1+0.1)3 + 10/(1+0.1)4 - 1000

NPV Project S = $39

NPV Project L = 0/(1+0.1) - 250/(1+0.1) 2 + 400/(1+0.1)3 + 800/(1+0.1)4 - 1000

NPV Project L = $54

Changing k = 12% in above equation: NPV Project L = -8$

Changing k = 11.5% in above equation: NPV Project L = -7$

Changing k = 11.75% in above equation: NPV Project L = 0$

Project L is better due to higher NPV

The IRR of Project L is 11.75%

Question 13-15:

After discovering a new gold vein in the Colorado Mountains, CTC Mining Corporation must decide whether to go
ahead and develop the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process
that could result in environmental damage. Before proceeding with the extraction, CTC must spend $900,000 for
mining equipment and pay $165,000 for its installation. The gold mined will net the company an estimated $350,000
each year for the five-year life of the vein, based on the current price of gold. CTC’s cost of capital is 14%. For the
purposes of this problem, assume that the cash inflows occur at the end of each year.

a. What are the project’s NPV and IRR?

b. Should this project be undertakes, ignoring environmental conerns?

Solution:

NPV = 350000(1-1.14^-5)/0.14 - 900000 - 165000 = $136,578

Changing k = 16% in above equation: NPV = 81,003$

Changing k = 19.2% in above equation: NPV = 412 ~ 0

The project IRR is 19.2%

Yes it should be selected as it has Positive NPV and higher rate of return than required