Fin 3110 Assignment 6

An investment project requires a net investment of $100,000 and is expected to generate annual net cash inflows of $25,000 for 6 years. The firm's cost of capital is 12%. Determine the profitability index for this project.

1.028 Solution: PI = [$25,000(PVIFA0.12,6)]/$100,000 = [$25,000(4.111)]/$100,000 = 1.028

Decode Genetics purchased lab equipment for $600,000 that will generate net cash flows of $130,000 per year for 10 years. What is the IRR for this project?

17.26% Solution: IRR = 17.26 (by calculator)

What is the internal rate of return for a project that has a net investment of $76,000 and net cash flows of $20,507 per year for 7 years?

19% Solution: PVIFAr,7 = $76,000/$20,507 = 3.706 Therefore, IRR = 19% from Table IV

GoFlo is a small growing firm that is considering the purchase of another truck to serve GoFlo's expanding customer base. The new truck will cost $21,000 and should generate annual net cash flows of $6,000 over the truck's 5-year life. What is the payback period for this project?

3.5 year

Which of the following statements about comparing the techniques of net present value (NPV) and internal rate of return (IRR) is (are) correct? I. The net present value assumes that all cash flows are reinvested at the cost of capital and is therefore realistic. II. The internal rate of return is stated as a percent and is therefore easy to communicate to decision-makers who may not understand the fine points of finance.

Both statements I and II are correct.

Dorati Inc. is considering two mutually exclusive projects. Dorati used a 15% required rate of return to evaluate capital expenditure projects. Assuming the two projects have the costs and cash flows shown below, determine the NPV for each using a replacement chain. Year /Project S /Project T 0 /-$70,000 /-$100,000 1 /$50,000 /$ 60,000 2 /$60,000 /$ 70,000 3 / /$ 80,000 4 / /$ 90,000 Assume in two years Project S will still cost $70,000 and produce the same two years of cash flows.

NPVs = $40,020: NPVT = $109,240 Solution: NPVT = -100,000 + 60,000(0.870) + 70,000(0.756) + 80,000(0.658) + 90,000(0.572) = $109,240 NPVs = -70,000 - 70,000(0.658) + 50,000(0.870) + 60,000(0.756) + 50,000(0.658) + 60,000(0.572) = 40,000

Consider a capital expenditure project that has forecasted revenues equal to $32,000 per year; cash expenses are estimated to be $29,000 per year. The cost of the project equipment is $23,000, and the equipment's estimated salvage value at the end of the project is $9,000. The equipment's $23,000 cost will be depreciated on a straight-line basis to $0 over a 10-year estimated economic life. Assume that the project requires an initial $7,000 working capital investment. The company's marginal tax rate is 30%. Calculate the project's net present value using a 12% discount rate.

about -$9,954 Solution: NINV = $23,000 + $7,000 = $30,000 NCF1-9 = ($32,000 - $29,000 - $2,300)(1 - 0.3) + $2,300 = $2,790 NCF10 = $2,790 + $7,000 + 9,000(0.7) = $16,090 NPV = -$9,954 (using calculator)

Real options in capital budgeting can be classified. The classification that means that the project is delayed and can be termed "waiting to invest" is the ____ option.

investment timing

The choice to accept or reject projects based on the payback period ____.

is a subjective decision

The ____ is interpreted as the ____ for each dollar of initial investment.

profitability index; present value return