1. An investment project provides cash inflows of P840,000 per year for eight years.

What is the
project payback period if the initial cost is P3,000,000? What if the initial cost if P5,000,000?
What if it is P7,000,000?

a.

b.
 c.

2. An investment project has annual cash inflows of P7,000,000, P7,500,000, P8,000,000 and
P8,500,000 and a discount rate of 14 percent. What is the discounted payback period for these
cash flows if the initial cost is P8,000,000? What if the initial is P13,000,000? What if it is
P18,000,000?

a.

b.

c.
3. A firm evaluates all of its projects by applying the IRR rule. If the required return is 18 percent,
should the firm accept the following projects?

Year Cash Flows

0 (P30,000,000)
1 20,000,000
2 14,000,000
3 11,000,000

Solution:

Decision:

The firm should accept the project

because the project’s IRR of 26% is
greater than the required return of
18%.
4. For the cash flows in the previous problem, suppose the firm uses the NPV decision rule. At a
required return of 11 percent, should the firm accept this project? What if the required return
was 30 percent?

Solution:

Decision:
In situation 1, with the required return
of 11%, the firm should accept the
project because the NPV is positive or
greater than 0.

While in the second situation, with the

required return of 30%, the firm
should reject the project because the
NPV is negative or less than 0

5. A project that provides annual cash flows of P14,000,000 for nine years costs P7,000,000 today.
Is this a good project if the required return is 8 percent? What if it is 16 percent? At what
discount rate would you be indifferent between accepting the project and rejecting it?

Decision:
Both situations have a positive NPV or greater than 0 NPV that the
firm can assume that these projects are good and should be
accepted. Furthermore, the project’s IRR resulted in 200%, more
significant than the interest rate, which means that this project is
acceptable.
6. The Yurdone Corporation wants to set up a private cemetery business. According to the CFO,
business is “looking up”. As a result, the cemetery project will provide a net cash inflow of
P500,000 for the firm during the first year, and the cash flow are projected to grow at a rate of
6 percent per year forever. The project requires an initial investment of P7,800,000.

a. If Yurdone requires a 13 percent return on such undertakings, should the cemetery

business be started?

Solution:

b. The company is somewhat unsure about the assumption of a 6 percent growth rate
in its cash flows. At what constant growth rate would the company just break even if
it still required a 13 percent return on investment?

Solution:

7. Suppose that your college roommate has approached you with an opportunity to lend $25,000
to her fledgling home healthcare business. The business called Home Health, Inc. plans to offer
home infusion therapy and monitored in-the-home healthcare services to surgery patients in the
Birmingham, Alabama area. Funds would be used to lease a delivery vehicle, purchase supplies,
and provide working capital. Terms of the proposal are that you would receive $5,000 at the
end of each year in interest with the full $25,000 to be repaid at the end of a 10-year period.

Solution: (All answers on No.7 are based on this table)

 a. Assuming a 10 percent required rate of return, calculate the present value of cash
flows and the net present value of the proposed investment.

b. Based on this same interest rate assumption, calculate the cumulative cash flow of the
proposed investment for each period in both nominal and present value terms.

c. What is the payback period in both nominal and present value terms?

d. What is the difference between the nominal and present value payback period? Can
the present value payback period ever be shorter than the nominal payback period?
➢ The present value payback period is always longer than the nominal payback period,
assuming a positive rate of interest. This is due to the fact that present value money is
always smaller than nominal value money, hence receiving a set amount of money in
present value rather than nominal terms takes longer.

8. Bob Sponge has been retained to analyze two proposed capital investment projects, project X
and Y, by Square Pants, Inc., a local specialty retailer. Project X is a sophisticated working
capital and inventory control system based upon a powerful personal computer, called a system
server and PC software specifically designed for inventory processing and control in the
retailing business. Project Y is a similarly sophisticated working capital and inventory control
system based upon a powerful personal computer and general-purpose PC software. Each
project has a cost of $10,000, and the cost of capital for both projects is 12 percent. The project’s
expected net cash flows are as follows:

Expected Net Cash Flow

Year Project X Project Y

0 ($10,000) ($10,000)
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500

a. Calculate each project’s nominal payback period, net present value (NPV), and
internal rate of return (IRR).

b. Should both projects be accepted if they are interdependent?

➢ Project X is recommended above Project Y as it has better results using all methods
since all projects meet the NPV and IRR requirements. Furthermore, if both projects
are self-contained or independent, the entity should accept them.

c. Which project should be accepted if they are mutually exclusive?

➢ If the projects are mutually exclusive, the entity should choose Project X as it has a higher
NPV at 12%.