FIN 300 FINAL (Chp. 9)

A project will produce cash inflows of $3,100 a year for 3 years with a final cash inflow of $4,400 in Year 4. The project's initial cost is $10,400. What is the net present value if the required rate of return is 16 percent? -$311.02 -$1,007.66 $1,650.11 $2,188.98 $1,168.02

-$1,007.66

ALUM, Inc. uses high-tech equipment to produce specialized aluminum products for its customers. Each one of these machines costs $1,520,000 to purchase plus an additional $48,000 a year to operate. The machines have a five-year life after which they are worthless. What is the equivalent annual cost of one these machines if the required return is 15.5 percent? -$506,819.32 -$427,109.10 -$335,803.37 -$295,666.67 -$556,947.08

-$506,819.32 NPV = -$1,520,000 - $48,000({1 - [1 / (1.155)^5]} / .155) = -$1,679,016.85 -$1,679,016.85 = EAC({1 - [1 / (1.155)^5]} / .155) EAC = -$506,819.32

Assume a project has cash flows of -$51,300, $18,200, $37,300, and $14,300 for years 0 to 3, respectively. What is the profitability index given a required return of 12.5 percent? .94 .98 1.09 1.06 1.11

1.09 PVInflows= $18,200 / 1.125 + $37,300 / 1.125^2 + $14,300 / 1.125^3 = $55,692.73 PI = $55,692.73 / $51,300 = 1.09

You are considering a project with an initial cost of $8,600. What is the payback period for this project if the cash inflows are $2,100, $3,140, $3,800, and $4,500 a year over the next four years, respectively? 2.88 years 3.28 years 3.36 years 4.21 years 2.29 years

2.88 years Payback = 2 + ($8,600 - 2,100 - 3,140) / $3,800 = 2.88 years

Precision Dyes is analyzing two machines to determine which one it should purchase. The company requires a rate of return of 14 percent and uses straight-line depreciation to a zero book value over the life of its equipment. Machine A has a cost of $512,000, annual aftertax cash outflows of $34,200, and a four-year life. Machine B costs $798,000, has annual aftertax cash outflows of $21,500, and has a six-year life. Whichever machine is purchased will be replaced at the end of its useful life. The firm should purchase Machine _____ because it lowers the firm's annual costs by approximately _______ as compared to the other machine. A; $16,791 A; $17,404 B; $16,791 B; $17,404 B; $17,521

A; $16,791 NPVA = -$512,000 - $34,200({1 - [1 / (1.14)^4]} / .14) = -$611,648.96 - $611,648.96 = EACA({1 - [1 / (1.14)^4]} / .14) EACA= -$209,920.85 NPVB = -$798,000 - $21,500({1 - [1 / (1.14)^6]} / .14) = -$881,606.35 -$881,606.35 = EACB({1 - [1 / (1.14)^6]} / .14) EACB = -$226,711.68 Difference in costs = -$209,920.85 - (-$226,711.68) = $16,790.83 Machine A lowers the firm's annual costs by about $16,791.

Isaac has analyzed two mutually exclusive projects that have 3-year lives. Project A has an NPV of $81,406, a payback period of 2.48 years, and an AAR of 9.31 percent. Project B has an NPV of $82,909, a payback period of 2.57 years, and an AAR of 9.22 percent. The required return for Project A is 11.5 percent while it is 12 percent for Project B. Both projects have a required AAR of 9.25 percent. Isaac must make a recommendation and justify it in 15 words or less. What should his recommendation be? Accept both projects because both NPVs are positive. Accept Project A because it has the shortest payback period. Accept Project B and reject Project A based on the NPVs. Accept Project A and reject Project B based on their AARs. Accept Project A because it has the lower required return.

Accept Project B and reject Project A based on the NPVs.

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.

Which one of the following is an advantage of the average accounting return method of analysis? Easy availability of information needed for the computation. Inclusion of time value of money considerations. The use of a cutoff rate as a benchmark. The use of pre-tax income in the computation. Use of real, versus nominal, average income.

Easy availability of information needed for the computation.

In actual practice, managers most frequently use which two types of investment criteria? NPV and payback. AAR and IRR. IRR and NPV. IRR and payback. NPV and PI.

IRR and NPV.

Which one of the following will decrease the net present value of a project? Increasing the value of each of the project's discounted cash inflows. Moving each of the cash inflows forward to a sooner time period. Decreasing the required discount rate. Increasing the project's initial cost at time zero. Increasing the amount of the final cash inflow.

Increasing the project's initial cost at time zero.

Net present value: Is the best method of analyzing mutually exclusive projects. Is less useful than the internal rate of return when comparing different sized projects. Is the easiest method of evaluation for nonfinancial managers to use. Cannot be applied when comparing mutually exclusive projects. Is very similar in its methodology to the average accounting return.

Is the best method of analyzing mutually exclusive projects.

Which one of the following correctly applies to the average accounting rate of return? It considers the time value of money. It measures net income as a percentage of the sales generated by a project. It is the best method of analyzing mutually exclusive projects from a financial point of view. It is the primary methodology used in analyzing independent projects. It can be compared to the return on assets ratio.

It can be compared to the return on assets ratio.

Which of the following are advantages of the payback method of project analysis? Considers time value of money, liquidity bias. Liquidity bias, arbitrary cutoff point. Liquidity bias, ease of use. Ignores time value of money, ease of use. Ease of use, arbitrary cutoff point.

Liquidity bias, ease of use.

You are viewing a graph that plots the NPVs of a project to various discount rates that could be applied to the project's cash flows. What is the name given to this graph? Project tract. Projected risk profile. NPV profile. NPV route. Present value sequence.

NPV profile.

The profitability index is most closely related to which one of the following? Payback. Discounted payback. Average accounting return. Net present value. Modified internal rate of return.

Net present value.

You estimate that a project will cost $27,700 and will provide cash inflows of $11,800 in year 1 and $24,600 in year 3. Based on the profitability index rule, should the project be accepted if the discount rate is 14 percent? Why or why not? Yes; The PI is .97. Yes; The PI is .84. Yes; The PI is 1.06. No; The PI is 1.06. No; The PI is .97.

No; The PI is .97. PVInflows = $11,800 / 1.14 + $24,600 / 1.14^3 = $26,955.18 PI = $26,955.18 / $27,700 = .97 The PI is less than 1 so the project should be rejected.

Which two methods of project analysis are the most biased towards short-term projects? Net present value and internal rate of return. Internal rate of return and profitability index. Payback and discounted payback. Net present value and discounted payback. Discounted payback and profitability index.

Payback and discounted payback.

You are considering two mutually exclusive projects. Both projects have an initial cost of $52,000. Project A produces cash inflows of $25,300, $37,100, and $22,000 for years 1 through 3, respectively. Project B produces cash inflows of $43,600, $19,800 and $10,400 for years 1 through 3, respectively. The required rate of return is 14.2 percent for Project A and 13.9 percent for Project B. Which project should you accept and why? Project A; because it has the higher required rate of return. Project A; because it has the larger NPV. Project B; because it has the largest cash inflow in year 1. Project B; because it has the lower required rate of return. Project B; because it has the larger NPV

Project A; because it has the larger NPV. NPVA = -$52,000 + $25,300 / 1.142 + $37,100 / 1.142^2 + $22,000 / 1.142^3 NPVA = $13,372.95 NPVB = -$52,000 + $43,600 / 1.139 + $19,800 / 1.1392 + $10,400 /1.1393 NPVB = $8,579.62

JJ's is reviewing a project with a cost of $318,000, and cash inflows of $0, $47,000, $198,000, and $226,000 for Years 1 to 4, respectively. The required discount rate is 15.5 percent and the required discounted payback period is three years. Should the project be accepted? Why or why not? Accept; The discounted payback period is 2.18 years. Accept; The discounted payback period is 2.32 years. Accept; The discounted payback period is 2.98 years. Reject; The discounted payback period is 3.87 years. Reject; The project never pays back on a discounted basis.

Reject; The project never pays back on a discounted basis. Total discounted cash inflow = $47,000 / 1.155^2 + $198,000 / 1.155^3 + $226,000 / 1.155^4 = $290,729.70 The project should be rejected because it never pays back on a discounted basis.

Which one of the following statements related to the internal rate of return (IRR) is correct? The IRR yields the same accept and reject decisions as the net present value method given mutually exclusive projects. A project with an IRR equal to the required return would reduce the value of a firm if accepted. The IRR is equal to the required return when the net present value is equal to zero. Financing type projects should be accepted if the IRR exceeds the required return. The average accounting return is a better method of analysis than the IRR from a financial point of view.

The IRR is equal to the required return when the net present value is equal to zero.

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 also be equal to zero.

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

A project has a net present value of zero. Which one of the following best describes this project? The project has a zero percent rate of return. The project requires no initial cash investment. The project has no cash flows. The summation of all of the project's cash flows is zero. The project's cash inflows equal its cash outflows in current dollar terms.

The project's cash inflows equal its cash outflows in current dollar terms.

You are considering an investment that costs $152,000 and has projected cash flows of $71,800, $86,900, and -$11,200 for years 1 to 3, respectively. If the required rate of return 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.

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.

Garage, Inc., has identified the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) 0 -$ 29,800 -$ 29,800 1 15,200 4,700 2 13,100 10,200 3 9,600 16,000 4 5,500 17,600 a-1 What is the IRR for each of these projects? a-2 Using the IRR decision rule, which project should the company accept? a-3 Is this decision necessarily correct? b-1 If the required return is 10 percent, what is the NPV for each of these projects? b-2 Which project will the company choose if it applies the NPV decision rule? c. At what discount rate would the company be indifferent between these two projects?

a. The IRR is the interest rate that makes the NPV of the project equal to zero. The equation for the IRR of Project A is: 0 = -$29,800 + $15,200 / (1 + IRR) + $13,100 / (1 + IRR)^2 + $9,600 / (1 + IRR)^3 + $5,500 / (1 + IRR)^4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 20.36% The equation for the IRR of Project B is: 0 = -$29,800 + $4,700 / (1 + IRR) + $10,200 / (1 + IRR)^2 + $16,000 / (1 + IRR)^3 + $17,600 / (1 + IRR)^4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 18.46% Examining the IRRs of the projects, we see that the IRRA is greater than the IRRB, so IRR decision rule implies accepting Project A. This may not be a correct decision; however, because the IRR criterion has a ranking problem for mutually exclusive projects. To see if the IRR decision rule is correct or not, we need to evaluate the project NPVs. b. The NPV of Project A is: NPVA = -$29,800 + $15,200 / 1.10 + $13,100 / 1.102 + $9,600 / 1.103 + $5,500 / 1.104 NPVA = $5,813.82 And the NPV of Project B is: NPVB = -$29,800 + $4,700 / 1.10 + $10,200 / 1.10^2 + $16,000 / 1.10^3 + $17,600 / 1.10^4 NPVB = $6,944.55 The NPVB is greater than the NPVA, so we should accept Project B. c. To find the crossover rate, we subtract the cash flows from one project from the cash flows of the other project. Here, we will subtract the cash flows for Project B from the cash flows of Project A. Once we find these differential cash flows, we find the IRR. The equation for the crossover rate is: Crossover rate: 0 = $10,500 / (1 + R) + $2,900 / (1 + R)^2 - $6,400 / (1 + R)^3 - $12,100 / (1 + R)^4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: R = 14.17% At discount rates above 14.17 percent choose Project A; for discount rates below 14.17 percent choose Project B; indifferent between A and B at a discount rate of 14.17 percent.

Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) 0 -$ 340,000 -$ 51,500 1 55,000 25,000 2 75,000 23,000 3 75,000 20,500 4 450,000 15,600 Whichever project you choose, if any, you require a 16 percent return on your investment. a-1 What is the payback period for each project? a-2 If you apply the payback criterion, which investment will you choose? b-1 What is the discounted payback period for each project? b-2 If you apply the discounted payback criterion, which investment will you choose? c-1 What is the NPV for each project? c-2 If you apply the NPV criterion, which investment will you choose? d-1 What is the IRR for each project? d-2 If you apply the IRR criterion, which investment will you choose? e-1 What is the profitability index for each project? e-2 If you apply the profitability index criterion, which investment will you choose? f. Based on your answers in (a) through (e), which project will you finally choose?

a. The payback period for each project is: A: 3 + ($135,000 / $450,000) = 3.30 years B: 2 + ($3,500 / $20,500) = 2.17 years The payback criterion implies accepting Project B because it pays back sooner than Project A. b. The discounted payback for each project is: A: $55,000 / 1.16 + $75,000 / 1.162 + $75,000 / 1.163 = $151,200.34 $450,000 / 1.164 = $248,530.99 Discounted payback = 3 + ($340,000 - 151,200.34) / $248,530.99 = 3.76 years B: $25,000 / 1.16 + $23,000 / 1.162 = $38,644.47 $20,500 / 1.163 = $13,133.48 Discounted payback = 2 + ($51,500 - 38,644.47) / $13,133.48 = 2.98 years The discounted payback criterion implies accepting Project B because it pays back sooner than A. c. The NPV for each project is: A: NPV = -$340,000 + $55,000 / 1.16 + $75,000 / 1.162 + $75,000 / 1.163 + $450,000 / 1.164 NPV = $59,731.33 B: NPV = -$51,500 + $25,000 / 1.16 + $23,000 / 1.162 + $20,500 / 1.163 + $15,600 / 1.164 NPV = $8,893.69 The NPV criterion implies we accept Project A because Project A has a higher NPV than Project B. d. The IRR for each project is: A: $340,000 = $55,000 / (1 + IRR) + $75,000 / (1 + IRR)2 + $75,000 / (1 + IRR)3 + $450,000 / (1 + IRR)4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 21.99% B: $51,500 = $25,000 / (1 + IRR) + $23,000 / (1 + IRR)2 + $20,500 / (1 + IRR)3 + $15,600 / (1 + IRR)4 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 25.12% The IRR decision rule implies we accept Project B because the IRR for B is greater than the IRR for A. e. The profitability index for each project is: A: PI = ($55,000 / 1.16 + $75,000 / 1.162 + $75,000 / 1.163 + $450,000 / 1.164) / $340,000 = 1.176 B: PI = ($25,000 / 1.16 + $23,000 / 1.162 + $20,500 / 1.163 + $15,600 / 1.164) / $51,500 = 1.173 The profitability index criterion implies we accept Project A because its PI is greater than Project B's. f. The final decision should be based on the NPV since it does not have the ranking problem associated with the other capital budgeting techniques.