Professional Documents
Culture Documents
a. 534,819.11
b. 146,122.76
c. -201,229.71
d. -512,678.49
2. Carson Trucking is considering whether to expand its regional service center in Mohab, UT.
The expansion requires an expenditure of $10,000,000 on new service equipment and would
generate annual net cash inflows from reduced cost of operations equal to $2,500,000 per
year each for the next eight years. In the year eight the firm will also get back a cash flow
equal to the salvage value of the equipment which is valued at $ 1 million. Thus, in year
eight the investment cash inflows total $ 3,500,000. Calculate the the projects NVP using
each of the following discount rates:
a. 9%
b. 11%
c. 13%
d. 15%
a. 4,338,914.07
b. 3,299,233.40
c. 2,373,085.60
d. 1,545,205.5
3. Big Steve’s, makers of swizzle sticks, is considering the purchase of a new plastic stamping
machine. This investment requires an initial cash outlay of $100,000 and will generate net
cash inflows of $18,000 per year for 10 years.
a. What is the project’s NVP using a discount rate of 10%? Should the project be
accepted? Why or why not?
b. What is the project’s NVP using a discount rate of 15%? Should the project be
accepted? Why or why not?
c. What is the projects internal rate of return? Should the project be accepted? Why or
why not?
a. 10% = 10,602.21, yes, we accept the project because NPV is greater than 0.
c. IRR = 12.41%, in case of Discount Rate 10%, yes, since the IRR > DR. In case of Discount
Rate 15%, no, since the IRR < DR
4. Barry Boswell is a financial analyst for Dossman Metal Work, inc. and he is analyzing two
alternative configurations for the firms new plasma cutter shop. The two alternatives that are
denoted A and B below perform the same task although they both cost $80,000 to purchase
and install they offer very different cash flows. Alternative A has a useful life of 7 years
while alternative B will only last for 3 years. After tax cash flows of the two projects are as
follows:
a. Calculate each projects annual equivalent cost (EAC) given a 10% discount rate.
b. Which of the alternatives do you think Barry should select? Why?
Alternative A) CFo = (80,000), CO1 – CO7 = (20,000), DR= 10%, NPV = -177,368.38,
EAC = -36,432.44
Alternative B) CFo = (80,000), CO1 – CO3 = (6000), DR= 10%, NPV = -94,921.11,
EAC = -38,169.18
Choose alternative A since it has the lower cost of the two projects EACs
Eclipse) CFo = (1,400,000), CO1 = (25000), CO2 – 4 = (30000), CO5 – 10 = (40000), I = 12%,
Sabre) CFo = (800,000), CO1 – 2 = (50,000), CO3 – 4 = (60,000), CO5 = (80,000), I = 12%,
We choose Sabre, since It has the lower cost and EAC of the two projects.
6. What are the internal rates of return for the following projects:
a. An initial outlay of $10,000, resulting in a single cash inflow of $17,182 in 8 years.
b. An initial outlay of $10000, resulting in a single cash inflow of $48,077 in 10 years
c. An initial cash outlay of $10000, resulting in a single cash inflow of $115,231 in 20
years
d. An initial cash outlay of $10000, resulting in a single cash inflow of $13,680 in 3
years
a. IRR = 7%
b. IRR = 17%
c. IRR = 13%
d. IRR = 11%
a. IRR = 15%
b. IRR = 20%
c. IRR = 6%
d. IRR = 13%
8. East coast television is considering a project with an initial outlay of $X, (you will have to
determine this amount). It is expected that the project will produce a positive cash outflow of
$50000 a year at the end of each year for the next 15 years. The appropriate discount rate for
this project is 10%. If the project has a 14% IRR, what is the project’s NPV?
a. IRR = 19%
b. IRR = 30%
c. IRR = 11%
10.Jella cosmetics is considering a project that costs $800000 and is expected to last for 10
years and produce future cash flows of $175000 per year. If the appropriate discount rate is
12%, what is the project’s IRR?
11.Your investment advisor has offered you an investment that will provide you with a single
cash flow of $10000 at the end of 20 years if you pay premiums of $200 per year in the
interim period. Specifically the annual premiums begin immediately and extend to the end of
year 19. You then receive $10000 at the end of year 20. Find the IRR on this investment.
12.The cash flows for three independent projects are found below:
c. I=10%
I = 20%
13. Mode publishing is considering a new printing facility that will involve a large initial outlay
and then result in a series of positive cash flows for 4 years. The estimated cash flows
associated with this project are:
IRR = 20.41%
14.Emily’s soccer mania is considering building a new plant. This project would require an
initial cash outlay of $10,000,000 and would generate annual cash inflows of $3 million per
year for years 1 – 4. In year 5 the project will require an investment outlay of $5,000,000.
During year 6 – 10 the project will provide cash inflows of $ 5 million per year. Calculate
the project’s MIRR, given:
a. A discount rate of 10%
b. Discount rate of 12%
c. Discount rate of 14%
15.Carraway Trucking Company runs a fleet of long haul trucks and has recently expanded into
the Midwest where It has decided to build a maintenance facility. This project would require
an initial outlay of $20 million and would generate annual cash inflows of $ 4 million per
year for years 1 – 3. In year 4 the project will require an investment outlay of $5 million.
During years 5 – 10 the project will provide cash inflows of $2 million per year.
a. Calculate the projects NPV and IRR where the discount rate is 12%. Is the project a
worthwhile investment based on these two measures? Why or why not?
b. Calculate the project’s MIRR. Is the project a worthwhile investment based on this
measure? Why or why not?
16.Microwave Oven Programming, Inc. is considering construction of a new plant. The plant
will have initial cash outlay of $7 million ( CFo = -7,000,000 ) and will produce cash flows
of $3 million at the end of year 1, $4 million at the end of year 2, and $2 million at the end
of years 3 – 5. What is the IRR on this new plant?
IRR = 28.53%
17.The Dunder Muffin Paper Company is considering purchasing a new stamping machine that
costs $400,000. This new machine will produce cash inflows of $150,000 each year at the
end of years 1 – 17. In addition to the cash inflows, at the end of year 5, there will be a cash
outflow of $200,000. The company has a required rate of return of 12%. What is the MIRR
of the investment?
I = 12%
Year Cash Flow I = 12%
0 (400,000) (400,000)
1 150,000 N= 17, FV= 1,029,906.13
2 150,000 N= 16, FV= 919,559.048
3 150,000 N= 15, FV= 821,034.86
4 150,000 N= 14, FV= 733,066.84
5 (50,000) N= 4, PV= (31,775.94)
6 150,000 N= 12, FV= 584,396.40
7 150,000 N= 11, FV= 521,782.50
8 150,000 N= 10, FV= 465,877.23
9 150,000 N= 9, FV= 415,916.81
10 150,000 N= 8, FV= 371,394.48
11 150,000 N= 7, FV= 331,602.21
12 150,000 N= 6, FV= 296,073.40
13 150,000 N= 5, FV= 264,351.25
14 150,000 N= 4, FV= 236,027.91
15 150,000 N= 3, FV= 210,379.20
16 150,000 N= 2, FV= 188,160
17 150,000 150,000
18.Star Industries owns and operates landfills for several municipalities throughout the
Midwestern part of the US. Star typically contracts with the municipality to provide landfill
services for a period of 20 years. The firm then constructs a lined landfill that has capacity
for 5 years. The $10 million expenditure required to construct the new landfill results in
negative cash flows at the end of the years 0, 5, 10 and 15. This change in sign on the stream
of cash flows over the 20 year contract period introduces the potential for multiple IRRs, so
stars management has decided to use the MIRR to evaluate new landfill investment
contracts. The annual cash inflows to Star begin in year 1 and extend through year 20 and
are estimated to equal $3 million ( this doesn’t reflect the cost of constructing the landfill
every 5 years). Star uses 10% discount rate to evaluate its new projects. So it plans to
discount all the construction costs every 5 years back to year 0 using this rate before
calculating the MIRR.
a. NPV = 68,663.37
b. PI = 1.035
c. IRR = 10.17%
d. Yes, since NPV > 0, PI > 1, and IRR > I
20.Gio’s restaurant is considering a project with the following expected cash flows:
Year Project Cash Flow
0 ($150 million)
1 $90 million
2 $70 million
3 $90 million
4 $100 million
If the projects appropriate discount rate is 12%, what is the projects discounted payback?
21.The Callaway Cattle company is considering construction of a new feed handling system for
its feed lot in Abilene, Kansas. The new system will provide annual labor savings and reduce
waste totaling $200,000, while the initial investment is only $500,000. Callaways
management has used a simple payback method for evaluating new investments in the past
but plans to calculate the discounted payback to analyze the investment where the
appropriate discount rate for this type of project is 10%, what is the project’s discounted
payback period?
22.The Bar-none manufacturing company manufactures fence panels used in cattle feed lots
throughout the Midwest. Bas-none’s management is considering 3 investment projects for
next year but does not want to make any investment that requires more than 3 years to
recover the firms initial investment. The cashflows of the 3 projects ( A, B and C) are found
below:
a. Given bar-none’s 3 year payback period, which of the projects qualify for acceptance?
b. Rank the 3 projects using their payback period. Which project looks the best using this
criterion? Do you agree with this ranking? Why or why not?
c. If bar-none uses 10% discount rate to analyze projects, what is the discounted payback
period for each project? If the firm still maintains its 3 year payback policy for the
discounted payback, which project should the firm undertake?
Year Project Balance Project Balance Project Balance
A A B B C C
0 ($1000) (1000) ($10000) (10000) ($5000) (5000)
1 600 (400) 5000 (5000) 1000 (4000)
2 300 (100) 3000 (2000) 1000 (3000)
3 200 100 3000 1000 2000 (1000)
4 100 200 3000 4000 2000 1000
5 500 700 3000 7000 2000 3000
a. Project A: 2 + (100/200) = 2.5 years
Project B: 2 + (2000/3000) = 2.67 years
Project C: 3 + (1000/2000) = 3.5 Years
b. Ranking would be A first, B second and C third, the ranking is not very accurate since
the amount of investment varies greatly in the project A and B.
c.
Year Discounted Balance Discounted Balance Discounted Balance
Cash Flow (A) Cash Flow (B) Cash Flow (C)
(A) (B) (C)
0 (1000) (1000) (10000) (10000) (5000) (5000)
1 545.93 (454.55) 4545.45 (5454.55) 909.10 (4090.90)
2 247.93 (206.62) 2479.34 (2927.21) 826.45 (3264.45)
3 150.26 (56.36) 2253.94 (721.27) 1502.63 (1761.82)
4 68.30 11.94 2049.04 1327.77 1366.03 (395.79)
5 310.46 322.40 1862.76 3190.53 1241.84 846.05
Discounted Payback Period:
A = 3 + (56.36/68.30) = 3.83 Years
B = 3 + (721.27/2049.04) = 3.35 Years
C = 4 + (395.79/1241.84) = 4.32 Years
We should accept none of the above since all of them exceeds the 3 year limitation that Bar-
None requires.
23.Plato energy is an oil and gas exploration and development company located in Farmington
NM. The company drills shallow wells in hopes of finding significant oil and gas deposits.
The firm is considering 2 different drilling opportunities that have very different production
potential the first is in the Barnett Shale region of central Texas and the other is in the gulf
coast. The Barnett shale project requires a much larger initial investment but provides cash
flows (if successful) over a much longer period of time that the gulf coast opportunity. In
addition, the longer life of Barnett shale project also results in additional expenditures in
year 3 of the project to enhance production through the projects 10 year expected life. This
expenditure involves pumping either water or co2 down into the wells in order to increase
the flow of oil and gas from the structure. The expected cash flows for the two projects are:
24.
Year Barnett Shale Gulf coast
0 $(5,000,000) -$(1,500,000)
1 2,000,000 800,000
2 2,000,000 800,000
3 (1,000,000) 400,000
4 2,000,000 100,000
5 1,500,000
6 1,500,000
7 1,500,000
8 800,000
9 500,000
10 100,000
a.
b. Gulf Coast is the better alternative because It gives you a payback in a shorter amount of time
than Barnett Shale. The problem with calculating the payback period is that it ignores the Time
Value of Money, so the actual value of these cash flows may be inaccurate in terms of the
discounted payback.
d. ?
24.You are considering a project with an initial cash outlay of $80,000 and expected cash
flows of $20,000 at the end of each year for 6 years. the discount rate for this project is
10%.
a. What are the projects payback and discounted payback periods?
b. What is the project’s NPV?
c. What is the project’s PI?
d. What is the project’s IRR?
Answer 24)
b. NPV = 7105.21
c. IRR = 12.98%
25.You have been assigned the task of evaluating 2 mutually exclusive projects with the
following projected cash flows:
Project A
Project B =
Choose project B because It has the higher NPV of the 2 projects and its IRR > I.
26. You are considering 2 independent projects. Project A and Project B. the initial cash outlay
associated with project A is $50,000 and the initial cash outlay associated with project B is
$70,000. The discount rate on both projects is 12%. The expected annual cash flows from each
other are as follows:
Project A
NPV = -663.11
IRR = 11.53%
PI = 0.9867
Project B
NPV = 16,551.7
IRR = 3.18%
PI = 0.76
Neither project should be accepted since the NPV < 0 and PI < 1 in both project A and B.
27.Garmin Technologies Inc. operates a small chain of specialty retail stores throughout the
southwestern part of the US. The stores market technology based consumer products both in
their stores and over the internet with sales split roughly equally between the 2 channels of
distribution. The company’s products range from radar detection devices and GPS mapping
systems used in automobiles to home based home based weather monitoring systems. The
company recently began investigating on the possible acquisition of a regional warehousing
facility that could be used both to stock its retail shops and to make direct shipments to the
firms online customers. The warehouse facility would require an expenditure of $250,000
for a rented space in Oklahoma City, OK and would provide a source of cash flow spanning
the next 10 years. the estimated cash flows are found below:
The negative cashflow in year 5 reflects the cost of planned renovation and expansion of the
facility. Finally, in year 10 Garmin estimates some recovery of its investment at the close of the
lease and, consequently, a higher than usual cash flow. Garmin uses a 12% discount rate in
evaluating its investments.
IRR = 16.36%
c. NPV = 47,710.13
MINICASE
a. If RWE uses a 10% discount rate to evaluate investments of this type, what is the NPV?
What does this NPV indicate about the potential value RWE might create by purchasing
the new production line?
b. Calculate the IRR and PI for the investment. What do these 2 measures tell you about the
projects viability?
c. Calculate the payback and discounted payback for the investment. Interpret your
findings.
Minicase Answer)
Year After-tax Cash Flow Balance Discounted Cash Flows Balance of Discounted CF
0 $(3,000,000) (3,000,000) (3,000,000) (3,000,000)
1 700,000 (2,300,000) 636,363.64 (2,363,636.36)
2 700,000 (1,600,000) 578,512.40 (1,785,123.96)
3 700,000 (900,000) 525,920.36 (1,259,203.60)
4 700,000 (200,000) 478,109.42 (781,094.18)
5 (1,300,000) (1,500,000) (807,197.72) (1,588,291.9)
6 700,000 (800,000) 395,131.75 (1,193,160.15)
7 700,000 (100,000) 359,210.68 (833,949.47)
8 700,000 600,000 326,555.17 (507,394.30)
9 700,000 1,300,000 296,868.33 (210,525.97)
10 900,000 2,200,000 348,988.96 136,462.99
There is a difference of 2.47 Years between the Payback and the Discounted Payback period,
which is a very big difference, and it indicates the importance of considering Time value of
money when calculating the payback period.