Connect 9a

What is the profitability index for an investment with the following cash flows given a 14.5 percent required return? 0.94 0.98 1.02 1.06 1.11

1.02

It will cost $6,000 to acquire an ice cream cart. Cart sales are expected to be $3,600 a year for three years. After the three years, the cart is expected to be worthless as the expected life of the refrigeration unit is only three years. What is the payback period? 1.48 years 1.67 years 1.82 years 1.95 years 2.00 years

Payback period = $6,000/$3,600 = 1.67 years

A firm evaluates all of its projects by using the NPV decision rule. Year Cash Flow 0 -$30,000 1 19,000 2 16,000 3 7,000 Required: (a) At a required return of 29 percent, what is the NPV for this project? (b) At a required return of 34 percent, what is the NPV for this project?

Required: (a) At a required return of 29 percent, what is the NPV for this project? -2,395.68 (b) At a required return of 34 percent, what is the NPV for this project? -4,000.96 Explanation: (a): The NPV of a project is the PV of the outflows minus the PV of the inflows. The equation for the NPV of this project at an 29 percent required return is: NPV = - $30,000 + $19,000/1.29 + $16,000/1.292 + $7,000/1.293 = $-2,395.68 At an 29 percent required return, the NPV is negative, so we would reject the project. (b): The equation for the NPV of the project at a 34 percent required return is: NPV = - $30,000 + $19,000/1.34 + $16,000/1.342 + $7,000/1.343 = $-4,000.96 At a 34 percent required return, the NPV is negative, so we would reject the project.

If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be: independent. interdependent. mutually exclusive. economically scaled. operationally distinct.

mutually exclusive.

Southern Chicken is considering two projects. Project A consists of creating an outdoor eating area on the unused portion of the restaurant's property. Project B would use that outdoor space for creating a drive-thru service window. When trying to decide which project to accept, the firm should rely most heavily on which one of the following analytical methods? profitability index internal rate of return payback net present value accounting rate of return

net present value

Which one of the following methods determines the amount of the change a proposed project will have on the value of a firm? net present value discounted payback internal rate of return profitability index payback

net present value

If a project has a net present value equal to zero, then: the total of the cash inflows must equal the initial cost of the project. the project earns a return exactly equal to the discount rate. a decrease in the project's initial cost will cause the project to have a negative NPV. any delay in receiving the projected cash inflows will cause the project to have a positive NPV. the project's PI must be also be equal to zero.

the project earns a return exactly equal to the discount rate.

A project will produce cash inflows of $2,800 a year for 4 years with a final cash inflow of $5,700 in year 5. The project's initial cost is $9,500. What is the net present value of this project if the required rate of return is 16 percent? -$311.02 $1,048.75 $4,650.11 $9,188.98 $11,168.02

$1,048.75

XYZ Corp. is considering three mutually exclusive projects with the following net present values: Project A $3 million Project B $2 million Project C -$1 million Based on the NPVs of Project A, Project B, and Project C, what capital budgeting decision will XYZ Corp. make? Accept Project A Accept Project B Accept Project A and B Accept Project B and C Accept Project A, B, and C

Accept Project A

XYZ Corp. is considering three independent projects with the following net present values: Project A $1 million Project B $2 million Project C -$1 million Based on the NPVs of Project A, Project B, and Project C, what capital budgeting decision will XYZ Corp. make? Accept Project A Accept Project B Accept Project A and B Accept Project B and C Accept Project A, B, and C

Accept Project A and B

A project that provides annual cash flows of $10,100 for 7 years costs $47,593 today. Required: (a) If the required return is 15 percent, what is the NPV for this project? (b) Determine the IRR for this project.

Required: (a) If the required return is 15 percent, what is the NPV for this project? $-5,572.94 (b) Determine the IRR for this project. 11% Explanation: (a): The NPV of a project is the PV of the inflows minus the PV of the outflows. Since the cash inflows are an annuity, the equation for the NPV of this project at an 15 percent required return is: NPV = $10,100(PVIFA15%, 7) - $47,593= $-5,572.94 At an 15 percent required return, the NPV is negative, so we would reject the project. (b): We would be indifferent to the project if the required return was equal to the IRR of the project, since at that required return the NPV is zero. The IRR of the project is: 0 = $10,100(PVIFAIRR, 7) - $47,593 IRR = 11%

A firm evaluates all of its projects by applying the IRR rule. Year Cash Flow 0 -$34,169 1 22,000 2 17,000 3 10,000 Requirement 1: Determine the IRR for the above project. Requirement 2: If the required return is 28 percent, should the firm accept the above project?

Requirement 1: Determine the IRR for the above project. 23.72% Requirement 2: If the required return is 28 percent, should the firm accept the above project? No rev: 09_18_2012 Explanation: 1: The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equation that defines the IRR for this project is: 0 = -$34,169 + $22,000/(1+IRR) + $17,000/(1+IRR)2 + $10,000/(1+IRR)3 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 23.72% 2: Since the IRR is lesser than the required return we would reject the project.

You are considering an investment with the following cash flows. If the required rate of return for this investment is 15.5 percent, should you accept the investment based solely on the internal rate of return rule? Why or why not? Yes; The IRR exceeds the required return. Yes; The IRR is less than the required return. No; The IRR is less than the required return. No; The IRR exceeds the required return. You cannot apply the IRR rule in this case.

Since the cash flow direction changes twice, there are two IRRs. Thus, the IRR rule cannot be used to determine acceptance or rejection.

You are considering two independent projects with the following cash flows. The required return for both projects is 16 percent. Given this information, which one of the following statements is correct? You should accept Project A and reject Project B based on their respective NPVs. You should accept Project B and reject Project A based on their respective NPVs. You should accept Project A and reject Project B based on their respective IRRs. You should accept Project B and reject Project A based on their respective IRRs. You should accept both projects based on both the NPV and IRR decision rules.

You should accept both projects based on both the NPV and IRR decision rules.

The internal rate of return is defined as the: maximum rate of return a firm expects to earn on a project. rate of return a project will generate if the project in financed solely with internal funds. discount rate that equates the net cash inflows of a project to zero. discount rate which causes the net present value of a project to equal zero. discount rate that causes the profitability index for a project to equal zero.

discount rate which causes the net present value of a project to equal zero.