FIN355 Exam 2

Project A costs $84,500 and has cash flows of $32,300, $36,400, and $30,000 for Years 1 to 3, respectively. Project B has an initial cost of $79,000 and has cash flows of $30,000, $36,000, and $29,000 for Years 1 to 3, respectively. What is the incremental IRR of these two mutually exclusive projects?

0 = [−$84,500 − (−$79,000)] + ($32,300 − 30,000)/(1 + IRR) + ($36,400 − 36,000)/(1 + IRR)2 + ($30,000 − 29,000)/(1 + IRR3) IRR = −20.37%

Iron Works International is considering a project that will produce annual cash flows of $39,000, $47,700, $58,400, and $23,900 over the next four years, respectively. What is the internal rate of return if the project has an initial cost of $112,000?

0 = −$112,000 + $39,000/(1 + IRR) + $47,700/(1 + IRR)^2 + $58,400/(1 + IRR)^3 + $23,900/(1 + IRR)^4 IRR = .1949, or 19.49%

Iron Works International is considering a project that will produce annual cash flows of $37,900, $46,600, $57,300, and $22,800 over the next four years, respectively. What is the internal rate of return if the project has an initial cost of $113,100?

0 = −$113,100 + $37,900/(1 + IRR) + $46,600/(1 + IRR)2 + $57,300/(1 + IRR)3 + $22,800/(1 + IRR)4 IRR = .1759 or 17.59%

Iron Works International is considering a project that will produce annual cash flows of $37,800, $46,500, $57,200, and $22,700 over the next four years, respectively. What is the internal rate of return if the project has an initial cost of $113,200?

0 = −$113,200 + $37,800/(1 + IRR) + $46,500/(1 + IRR)2 + $57,200/(1 + IRR)3 + $22,700/(1 + IRR)4 IRR = .1742, or 17.42%

A project will generate annual cash flows of $237,000 for each of the next three years, and a cash flow of $273,800 during the fourth year. The initial cost of the project is $764,800. What is the internal rate of return of this project?

0 = −$764,800 + $237,000/(1 + IRR) + $237,000/(1 + IRR)2 + $237,000/(1 + IRR)3 + $273,800/(1 + IRR)4 IRR = .1068, or 10.68%

A project will generate annual cash flows of $237,600 for each of the next three years, and a cash flow of $274,800 during the fourth year. The initial cost of the project is $765,600. What is the internal rate of return of this project?

0 = −$765,600 + $237,600/(1 + IRR) + $237,600/(1 + IRR)^2 + $237,600/(1 + IRR)^3 + $274,800/(1 + IRR)^4 IRR = .1076, or 10.76%

A project with an initial cost of $29,700 is expected to provide cash flows of $9,450, $10,800, $13,900, and $8,400 over the next four years, respectively. If the required return is 8.2 percent, what is the project's profitability index?

1.180 PI = [$9,450/(1 + .082) + $10,800/(1 + .082)^2 + $13,900/(1 + .082)^3 + $8,400/(1 + .082)^4]/$29,700 PI = 1.180

A project will generate annual cash flows of $237,600 for each of the next three years, and a cash flow of $274,800 during the fourth year. The initial cost of the project is $748,600. What is the internal rate of return of this project?

11.80% 0 = −$748,600 + $237,600/(1 + IRR) + $237,600/(1 + IRR)^2 + $237,600/(1 + IRR)^3 + $274,800/(1 + IRR)^4 IRR = .1180, or 11.80%

Blue Bird Café is considering a project with an initial cost of $46,800, and cash flows of $8,500, $25,000, $19,000, and −$4,500 for Years 1 to 4, respectively. How many internal rates of return do you expect this project to have?

2

A project with an initial cost of $24,800 is expected to generate cash flows of $5,900, $8,000, $8,750, $7,650, and $6,700 over each of the next five years, respectively. What is the project's payback period?

Amount short after 3 years = $24,800 − 5,900 − 8,000 − 8,750 Amount short after 3 years = $2,150Payback period = 3 + $2,150/$7,650Payback period = 3.28 years

A project with an initial cost of $29,000 is expected to generate cash flows of $7,100, $9,200, $9,350, $8,250, and $7,900 over each of the next five years, respectively. What is the project's payback period?

Amount short after 3 years = $29,000 − 7,100 − 9,200 − 9,350 Amount short after 3 years = $3,350 Payback period = 3 + $3,350/$8,250Payback period = 3.41 years

A project with an initial cost of $29,350 is expected to generate cash flows of $7,200, $9,300, $9,400, $8,300, and $8,000 over each of the next five years, respectively. What is the project's payback period?

Amount short after 3 years = $29,350 − 7,200 − 9,300 − 9,400 Amount short after 3 years = $3,450 Payback period = 3 + $3,450/$8,300 Payback period = 3.42 years

Power Manufacturing has equipment that it purchased 5 years ago for $2,050,000. The equipment was used for a project that was intended to last for 7 years and was being depreciated over the life of the project. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $300,000 today. The company's tax rate is 35 percent. What is the aftertax salvage value of the equipment?

Annual depreciation = $2,050,000/7 Annual depreciation = $292,857 Book value = $2,050,000 − 5($292,857) Book value = $585,714 Tax refund (due) = ($585,714 − 300,000)(.35) Tax refund (due) = $100,000 Aftertax salvage value = $300,000 + 100,000 Aftertax salvage value = $400,000

Power Manufacturing has equipment that it purchased 4 years ago for $2,200,000. The equipment was used for a project that was intended to last for 6 years and was being depreciated over the life of the project. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $330,000 today. The company's tax rate is 35 percent. What is the aftertax salvage value of the equipment?

Annual depreciation = $2,200,000/6 Annual depreciation = $366,667 Book value = $2,200,000 − 4($366,667) Book value = $733,333 Tax refund (due) = ($733,333 − 330,000)(.35) Tax refund (due) = $141,167 Aftertax salvage value = $330,000 + 141,167 Aftertax salvage value = $471,167

Power Manufacturing has equipment that it purchased 7 years ago for $2,350,000. The equipment was used for a project that was intended to last for 9 years and was being depreciated over the life of the project. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $360,000 today. The company's tax rate is 35 percent. What is the aftertax salvage value of the equipment?

Annual depreciation = $2,350,000/9 Annual depreciation = $261,111 Book value = $2,350,000 − 7($261,111) Book value = $522,222 Tax refund (due) = ($522,222 − 360,000)(.35) Tax refund (due) = $56,778 Aftertax salvage value = $360,000 + 56,778 Aftertax salvage value = $416,778

Power Manufacturing has equipment that it purchased 6 years ago for $2,500,000. The equipment was used for a project that was intended to last for 8 years and was being depreciated over the life of the project. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $390,000 today. The company's tax rate is 35 percent. What is the aftertax salvage value of the equipment?

Annual depreciation = $2,500,000/8 Annual depreciation = $312,500 Book value = $2,500,000 − 6($312,500) Book value = $625,000 Tax refund (due) = ($625,000 − 390,000)(.35) Tax refund (due) = $82,250 Aftertax salvage value = $390,000 + 82,250 Aftertax salvage value = $472,250

Power Manufacturing has equipment that it purchased 7 years ago for $2,750,000. The equipment was used for a project that was intended to last for 9 years and was being depreciated over the life of the project. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $440,000 today. The company's tax rate is 34 percent. What is the aftertax salvage value of the equipment?

Annual depreciation = $2,750,000/9 Annual depreciation = $305,556 Book value = $2,750,000 − 7($305,556) Book value = $611,111 Tax refund (due) = ($611,111 − 440,000)(.34) Tax refund (due) = $58,178 Aftertax salvage value = $440,000 + 58,178 Aftertax salvage value = $498,178

Power Manufacturing has equipment that it purchased 6 years ago for $2,900,000. The equipment was used for a project that was intended to last for 8 years and was being depreciated over the life of the project. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $470,000 today. The company's tax rate is 34 percent. What is the aftertax salvage value of the equipment?

Annual depreciation = $2,900,000/8 Annual depreciation = $362,500 Book value = $2,900,000 − 6($362,500) Book value = $725,000 Tax refund (due) = ($725,000 − 470,000)(.34) Tax refund (due) = $86,700 Aftertax salvage value = $470,000 + 86,700 Aftertax salvage value = $556,700

Power Manufacturing has equipment that it purchased 7 years ago for $2,950,000. The equipment was used for a project that was intended to last for 9 years and was being depreciated over the life of the project. However, due to low demand, the project is being shut down. The equipment was depreciated using the straight-line method and can be sold for $480,000 today. The company's tax rate is 35 percent. What is the aftertax salvage value of the equipment?

Annual depreciation = $2,950,000/9 Annual depreciation = $327,778 Book value = $2,950,000 − 7($327,778) Book value = $655,556 Tax refund (due) = ($655,556 − 480,000)(.35) Tax refund (due) = $61,444 Aftertax salvage value = $480,000 + 61,444 Aftertax salvage value = $541,444

Which statement concerning the net present value (NPV) of an investment or a financing project is correct?

Any type of project should be accepted if the NPV is positive and rejected if it is negative.

Pear Orchards is evaluating a new project that will require equipment of $221,000. The equipment will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company plans to shut down the project after 4 years. At that time, the equipment could be sold for $48,900. However, the company plans to keep the equipment for a different project in another state. The tax rate is 34 percent. What aftertax salvage value should the company use when evaluating the current project?

Book value = $221,000 − 221,000(.2000 + .3200 + .1920 + .1152) Book value = $38,189 Tax refund (due) = ($38,189 − 48,900)(.34) Tax refund (due) = −$3,642 Aftertax salvage value = 48,900 − 3,642 Aftertax salvage value = $45,258

Pear Orchards is evaluating a new project that will require equipment of $223,000. The equipment will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company plans to shut down the project after 4 years. At that time, the equipment could be sold for $50,200. However, the company plans to keep the equipment for a different project in another state. The tax rate is 35 percent. What aftertax salvage value should the company use when evaluating the current project?

Book value = $223,000 − 223,000(.2000 + .3200 + .1920 + .1152) Book value = $38,534 Tax refund (due) = ($38,534 − 50,200)(.35) Tax refund (due) = −$4,083 Aftertax salvage value = 50,200 − 4,083 Aftertax salvage value = $46,117

Pear Orchards is evaluating a new project that will require equipment of $229,000. The equipment will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company plans to shut down the project after 4 years. At that time, the equipment could be sold for $54,100. However, the company plans to keep the equipment for a different project in another state. The tax rate is 35 percent. What aftertax salvage value should the company use when evaluating the current project?

Book value = $229,000 − 229,000(.2000 + .3200 + .1920 + .1152) Book value = $39,571 Tax refund (due) = ($39,571 − 54,100)(.35) Tax refund (due) = −$5,085 Aftertax salvage value = 54,100 − 5,085 Aftertax salvage value = $49,015

Pear Orchards is evaluating a new project that will require equipment of $231,000. The equipment will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company plans to shut down the project after 4 years. At that time, the equipment could be sold for $55,400. However, the company plans to keep the equipment for a different project in another state. The tax rate is 40 percent. What aftertax salvage value should the company use when evaluating the current project?

Book value = $231,000 − 231,000(.2000 + .3200 + .1920 + .1152) Book value = $39,917 Tax refund (due) = ($39,917 − 55,400)(.40) Tax refund (due) = −$6,193 Aftertax salvage value = 55,400 − 6,193 Aftertax salvage value = $49,207

Pear Orchards is evaluating a new project that will require equipment of $235,000. The equipment will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company plans to shut down the project after 4 years. At that time, the equipment could be sold for $58,000. However, the company plans to keep the equipment for a different project in another state. The tax rate is 35 percent. What aftertax salvage value should the company use when evaluating the current project?

Book value = $235,000 − 235,000(.2000 + .3200 + .1920 + .1152) Book value = $40,608 Tax refund (due) = ($40,608 − 58,000)(.35) Tax refund (due) = −$6,087 Aftertax salvage value = 58,000 − 6,087 Aftertax salvage value = $51,913

Pear Orchards is evaluating a new project that will require equipment of $235,000. The equipment will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company plans to shut down the project after 4 years. At that time, the equipment could be sold for $58,000. However, the company plans to keep the equipment for a different project in another state. The tax rate is 35 percent. What aftertax salvage value should the company use when evaluating the current project?

Book value = $235,000 − 235,000(.2000 + .3200 + .1920 + .1152) Book value = $40,608 Tax refund (due) = ($40,608 − 58,000)(.35) Tax refund (due) = −$6,087 Aftertax salvage value = 58,000 − 6,087 Aftertax salvage value = $51,913

Pear Orchards is evaluating a new project that will require equipment of $259,000. The equipment will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company plans to shut down the project after 4 years. At that time, the equipment could be sold for $73,600. However, the company plans to keep the equipment for a different project in another state. The tax rate is 35 percent. What aftertax salvage value should the company use when evaluating the current project?

Book value = $259,000 − 259,000(.2000 + .3200 + .1920 + .1152) Book value = $44,755 Tax refund (due) = ($44,755 − 73,600)(.35) Tax refund (due) = −$10,096 Aftertax salvage value = 73,600 − 10,096' Aftertax salvage value = $63,504

A 4-year project has an annual operating cash flow of $48,500. At the beginning of the project, $3,950 in net working capital was required, which will be recovered at the end of the project. The firm also spent $21,800 on equipment to start the project. This equipment will have a book value of $4,420 at the end of the project, but can be sold for $5,490. The tax rate is 34 percent. What is the Year 4 cash flow?

Cash flow = $48,500 + 3,950 + 5,490 + .34($4,420 − 5,490) Cash flow = $57,576

A 4-year project has an annual operating cash flow of $49,000. At the beginning of the project, $4,000 in net working capital was required, which will be recovered at the end of the project. The firm also spent $21,900 on equipment to start the project. This equipment will have a book value of $4,460 at the end of the project, but can be sold for $5,520. The tax rate is 35 percent. What is the Year 4 cash flow?

Cash flow = $49,000 + 4,000 + 5,520 + .35($4,460 − 5,520) Cash flow = $58,149

A 4-year project has an annual operating cash flow of $49,500. At the beginning of the project, $4,050 in net working capital was required, which will be recovered at the end of the project. The firm also spent $22,000 on equipment to start the project. This equipment will have a book value of $4,500 at the end of the project, but can be sold for $5,550. The tax rate is 40 percent. What is the Year 4 cash flow?

Cash flow = $49,500 + 4,050 + 5,550 + .40($4,500 − 5,550) Cash flow = $58,680

A 4-year project has an annual operating cash flow of $50,000. At the beginning of the project, $4,100 in net working capital was required, which will be recovered at the end of the project. The firm also spent $22,100 on equipment to start the project. This equipment will have a book value of $4,540 at the end of the project, but can be sold for $5,580. The tax rate is 34 percent. What is the Year 4 cash flow?

Cash flow = $50,000 + 4,100 + 5,580 + .34($4,540 − 5,580) Cash flow = $59,326

A 4-year project has an annual operating cash flow of $58,000. At the beginning of the project, $4,900 in net working capital was required, which will be recovered at the end of the project. The firm also spent $23,700 on equipment to start the project. This equipment will have a book value of $5,180 at the end of the project, but can be sold for $6,060. The tax rate is 35 percent. What is the Year 4 cash flow?

Cash flow = $58,000 + 4,900 + 6,060 + .35($5,180 − 6,060) Cash flow = $68,652

Homer is considering a project with cash inflows of $950 a year for Years 1 to 4, respectively. The project has a required discount rate of 11 percent and an initial cost of $2,100. What is the discounted payback period?

DPB = 2 + ($2,100 − $950/1.11 − $950/1.112)/($950/1.113) DPB = 2.68 years

For a profitable firm, an increase in which one of the following will increase the operating cash flow?

Depreciation

Seeing Red has a new project that will require fixed assets of $881,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company has a tax rate of 34 percent. What is the depreciation tax shield for Year 3?

Depreciation tax shield = .34($881,000(.1920)) Depreciation tax shield = $57,512

Seeing Red has a new project that will require fixed assets of $887,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company has a tax rate of 34 percent. What is the depreciation tax shield for Year 3?

Depreciation tax shield = .34($887,000(.1920)) Depreciation tax shield = $57,903

Seeing Red has a new project that will require fixed assets of $907,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company has a tax rate of 35 percent. What is the depreciation tax shield for Year 3?

Depreciation tax shield = .35($907,000(.1920)) Depreciation tax shield = $60,950

Seeing Red has a new project that will require fixed assets of $879,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company has a tax rate of 40 percent. What is the depreciation tax shield for Year 3?

Depreciation tax shield = .40($879,000(.1920)) Depreciation tax shield = $67,507

Seeing Red has a new project that will require fixed assets of $885,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company has a tax rate of 40 percent. What is the depreciation tax shield for Year 3?

Depreciation tax shield = .40($885,000(.1920)) Depreciation tax shield = $67,968

Seeing Red has a new project that will require fixed assets of $897,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company has a tax rate of 40 percent. What is the depreciation tax shield for Year 3?

Depreciation tax shield = .40($897,000(.1920)) Depreciation tax shield = $68,890

Seeing Red has a new project that will require fixed assets of $921,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company has a tax rate of 40 percent. What is the depreciation tax shield for Year 3?

Depreciation tax shield = .40($921,000(.1920)) Depreciation tax shield = $70,733

Which of the following methods of project analysis are biased towards short-term projects?

Discounted payback and payback

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $165,300 a year. The project will require new equipment costing $544,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $145,000 at the end of the project. The project requires an initial investment of $33,000 in net working capital, which will be recovered at the end of the project. The tax rate is 35 percent. What is the project's IRR?

IRR = 0 = −$544,000 − 33,000 + $165,300(PVIFAIRR,5) + [$33,000 + (1 − .35)($145,000)]/(1 + IRR)5 IRR = 17.69%

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $153,400 a year. The project will require new equipment costing $553,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $151,000 at the end of the project. The project requires an initial investment of $34,500 in net working capital, which will be recovered at the end of the project. The tax rate is 35 percent. What is the project's IRR?

IRR = 0 = −$553,000 − 34,500 + $153,400(PVIFAIRR,5) + [$34,500 + (1 − .35)($151,000)]/(1 + IRR)5 IRR = 14.52%

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $132,900 a year. The project will require new equipment costing $556,000 that would be depreciated on a straight-line basis to zero over the 6-year life of the project. The equipment will have a market value of $153,000 at the end of the project. The project requires an initial investment of $35,000 in net working capital, which will be recovered at the end of the project. The tax rate is 40 percent. What is the project's IRR?

IRR = 0 = −$556,000 − 35,000 + $132,900(PVIFAIRR,6) + [$35,000 + (1 − .40)($153,000)]/(1 + IRR)6 IRR = 13.07%

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $176,600 a year. The project will require new equipment costing $598,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $181,000 at the end of the project. The project requires an initial investment of $42,000 in net working capital, which will be recovered at the end of the project. The tax rate is 35 percent. What is the project's IRR?

IRR = 0 = −$598,000 − 42,000 + $176,600(PVIFAIRR,5) + [$42,000 + (1 − .35)($181,000)]/(1 + IRR)5 IRR = 16.87%

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $176,600 a year. The project will require new equipment costing $598,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $181,000 at the end of the project. The project requires an initial investment of $42,000 in net working capital, which will be recovered at the end of the project. The tax rate is 35 percent. What is the project's IRR?

IRR = 0 = −$598,000 − 42,000 + $176,600(PVIFAIRR,5) + [$42,000 + (1 − .35)($181,000)]/(1 + IRR)5 IRR = 16.87%

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $164,500 a year. The project will require new equipment costing $607,000 that would be depreciated on a straight-line basis to zero over the 5-year life of the project. The equipment will have a market value of $187,000 at the end of the project. The project requires an initial investment of $43,500 in net working capital, which will be recovered at the end of the project. The tax rate is 35 percent. What is the project's IRR?

IRR = 0 = −$607,000 − 43,500 + $164,500(PVIFAIRR,5) + [$43,500 + (1 − .35)($187,000)]/(1 + IRR)5 IRR = 14.00%

Cirice Corp. is considering opening a branch in another state. The operating cash flow will be $164,600 a year. The project will require new equipment costing $610,000 that would be depreciated on a straight-line basis to zero over the 6-year life of the project. The equipment will have a market value of $189,000 at the end of the project. The project requires an initial investment of $44,000 in net working capital, which will be recovered at the end of the project. The tax rate is 40 percent. What is the project's IRR?

IRR = 0 = −$610,000 − 44,000 + $164,600(PVIFAIRR,6) + [$44,000 + (1 − .40)($189,000)]/(1 + IRR)6 IRR = 16.90%

Why do managers suggest that ignoring all cash flows following the required payback period is not a major flaw of the payback method of capital budgeting analysis?

If the cash flows after the required period are significant, managers will use their discretion to override the payback rule.

Bruno's Lunch Counter is expanding and expects operating cash flows of $26,100 a year for 4 years as a result. This expansion requires $62,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $3,600 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 12 percent?

NPV = 0 = −$62,000 − 3,600 + 26,100(PVIFA12%,4) + 3,600/1.124 NPV = $15,963

Bruno's Lunch Counter is expanding and expects operating cash flows of $26,100 a year for 4 years as a result. This expansion requires $62,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $3,600 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 12 percent?

NPV = 0 = −$62,000 − 3,600 + 26,100(PVIFA12%,4) + 3,600/1.124 NPV = $15,963

Bruno's Lunch Counter is expanding and expects operating cash flows of $26,700 a year for 4 years as a result. This expansion requires $64,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $3,800 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 13 percent?

NPV = 0 = −$64,000 − 3,800 + 26,700(PVIFA13%,4) + 3,800/1.134 NPV = $13,949

Bruno's Lunch Counter is expanding and expects operating cash flows of $27,300 a year for 4 years as a result. This expansion requires $65,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $4,000 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 14 percent?

NPV = 0 = −$65,000 − 4,000 + 27,300(PVIFA14%,4) + 4,000/1.144NPV = $12,913

Bruno's Lunch Counter is expanding and expects operating cash flows of $28,500 a year for 4 years as a result. This expansion requires $67,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $4,400 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 11 percent?

NPV = 0 = −$67,000 − 4,400 + 28,500(PVIFA11%,4) + 4,400/1.114 NPV = $19,918

Bruno's Lunch Counter is expanding and expects operating cash flows of $25,600 a year for 5 years as a result. This expansion requires $69,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $5,800 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 13 percent?

NPV = 0 = −$69,000 − 5,800 + 25,600(PVIFA13%,5) + 5,800/1.135 NPV = $18,389

Bruno's Lunch Counter is expanding and expects operating cash flows of $24,600 a year for 6 years as a result. This expansion requires $76,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $6,000 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 10 percent?

NPV = 0 = −$76,000 − 6,000 + 24,600(PVIFA10%,6) + 6,000/1.106 NPV = $28,526

Rossdale Flowers has a new greenhouse project with an initial cost of $355,000 that is expected to generate cash flows of $46,300 for 11 years and a cash flow of $61,700 in Year 12. If the required return is 8.5 percent, what is the project's NPV?

NPV = −$355,000 + $46,300(PVIFA8.50%, 11) + $61,700/(1 + .085)12 NPV = −$9,155.23

What is the net present value of a project with an initial cost of $36,900 and cash inflows of $13,400, $21,600, and $10,000 for Years 1 to 3, respectively? The discount rate is 13 percent.

NPV = −$36,900 + $13,400/1.13 + $21,600/1.13^2 + $10,000/1.13^3 NPV = −$1,195.12

Rossdale Flowers has a new greenhouse project with an initial cost of $360,000 that is expected to generate cash flows of $45,100 for 11 years and a cash flow of $60,500 in Year 12. If the required return is 7.9 percent, what is the project's NPV?

NPV = −$360,000 + $45,100(PVIFA7.90%, 11) + $60,500/(1 + .079)12NPV = −$12,170.92

Assume a firm has no interest expense or extraordinary items. Given this, the operating cash flow can be computed as:

Net income + Depreciation.

A project is expected to generate annual revenues of $117,700, with variable costs of $74,800, and fixed costs of $15,300. The annual depreciation is $3,850 and the tax rate is 35 percent. What is the annual operating cash flow?

OCF = ($117,700 − 74,800 − 15,300)(1 − .35) + .35($3,850) OCF = $19,288

A project is expected to generate annual revenues of $120,100, with variable costs of $75,700, and fixed costs of $16,200. The annual depreciation is $4,000 and the tax rate is 35 percent. What is the annual operating cash flow?

OCF = ($120,100 − 75,700 − 16,200)(1 − .35) + .35($4,000) OCF = $19,730

A project is expected to generate annual revenues of $120,900, with variable costs of $76,000, and fixed costs of $16,500. The annual depreciation is $4,050 and the tax rate is 40 percent. What is the annual operating cash flow?

OCF = ($120,900 − 76,000 − 16,500)(1 − .40) + .40($4,050) OCF = $18,660

A project is expected to generate annual revenues of $121,700, with variable costs of $76,300, and fixed costs of $16,800. The annual depreciation is $4,100 and the tax rate is 34 percent. What is the annual operating cash flow?

OCF = ($121,700 − 76,300 − 16,800)(1 − .34) + .34($4,100) OCF = $20,270

A project is expected to generate annual revenues of $129,700, with variable costs of $79,300, and fixed costs of $19,800. The annual depreciation is $4,600 and the tax rate is 35 percent. What is the annual operating cash flow?

OCF = ($129,700 − 79,300 − 19,800)(1 − .35) + .35($4,600) OCF = $21,500

A project is expected to generate annual revenues of $130,500, with variable costs of $79,600, and fixed costs of $20,100. The annual depreciation is $4,650 and the tax rate is 40 percent. What is the annual operating cash flow?

OCF = ($130,500 − 79,600 − 20,100)(1 − .40) + .40($4,650) OCF = $20,340

A project is expected to generate annual revenues of $133,700, with variable costs of $80,800, and fixed costs of $21,300. The annual depreciation is $4,850 and the tax rate is 35 percent. What is the annual operating cash flow?

OCF = ($133,700 − 80,800 − 21,300)(1 − .35) + .35($4,850) OCF = $22,238

King Nothing is evaluating a new 6-year project that will have annual sales of $380,000 and costs of $266,000. The project will require fixed assets of $480,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 35 percent. What is the operating cash flow for Year 3?

OCF = ($380,000 − 266,000)(1 − .35) + .35(.1920)($480,000) OCF = $106,356

King Nothing is evaluating a new 6-year project that will have annual sales of $385,000 and costs of $269,000. The project will require fixed assets of $485,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 40 percent. What is the operating cash flow for Year 3?

OCF = ($385,000 − 269,000)(1 − .40) + .40(.1920)($485,000) OCF = $106,848

King Nothing is evaluating a new 6-year project that will have annual sales of $410,000 and costs of $284,000. The project will require fixed assets of $510,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 35 percent. What is the operating cash flow for Year 3?

OCF = ($410,000 − 284,000)(1 − .35) + .35(.1920)($510,000) OCF = $116,172

King Nothing is evaluating a new 6-year project that will have annual sales of $415,000 and costs of $287,000. The project will require fixed assets of $515,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 40 percent. What is the operating cash flow for Year 3?

OCF = ($415,000 − 287,000)(1 − .40) + .40(.1920)($515,000)OCF = $116,352

King Nothing is evaluating a new 6-year project that will have annual sales of $425,000 and costs of $293,000. The project will require fixed assets of $525,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 35 percent. What is the operating cash flow for Year 3?

OCF = ($425,000 − 293,000)(1 − .35) + .35(.1920)($525,000) OCF = $121,080

King Nothing is evaluating a new 6-year project that will have annual sales of $440,000 and costs of $302,000. The project will require fixed assets of $540,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 35 percent. What is the operating cash flow for Year 3?

OCF = ($440,000 − 302,000)(1 − .35) + .35(.1920)($540,000) OCF = $125,988

King Nothing is evaluating a new 6-year project that will have annual sales of $475,000 and costs of $323,000. The project will require fixed assets of $575,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 40 percent. What is the operating cash flow for Year 3?

OCF = ($475,000 − 323,000)(1 − .40) + .40(.1920)($575,000) OCF = $135,360

King Nothing is evaluating a new 6-year project that will have annual sales of $495,000 and costs of $335,000. The project will require fixed assets of $595,000, which will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, 11.52 percent, and 5.76 percent, respectively. The company has a tax rate of 35 percent. What is the operating cash flow for Year 3?

OCF = ($495,000 − 335,000)(1 − .35) + .35(.1920)($595,000) OCF = $143,984

Rock Haven has a proposed project that will generate sales of 1,725 units annually at a selling price of $23 each. The fixed costs are $13,400 and the variable costs per unit are $6.35. The project requires $28,600 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the 4-year life of the project. The salvage value of the fixed assets is $7,100 and the tax rate is 35 percent. What is the operating cash flow?

OCF = [1,725($23 − 6.35) − $13,400](1 − .35) + .35($28,600/4) OCF = $12,461

Rock Haven has a proposed project that will generate sales of 1,800 units annually at a selling price of $28 each. The fixed costs are $15,900 and the variable costs per unit are $8.35. The project requires $31,600 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the 4-year life of the project. The salvage value of the fixed assets is $8,100 and the tax rate is 34 percent. What is the operating cash flow?

OCF = [1,800($28 − 8.35) − $15,900](1 − .34) + .34($31,600/4) OCF = $15,536

Rock Haven has a proposed project that will generate sales of 1,845 units annually at a selling price of $31 each. The fixed costs are $17,400 and the variable costs per unit are $9.55. The project requires $33,400 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the 4-year life of the project. The salvage value of the fixed assets is $8,700 and the tax rate is 34 percent. What is the operating cash flow?

OCF = [1,845($31 − 9.55) − $17,400](1 − .34) + .34($33,400/4) OCF = $17,475

Rock Haven has a proposed project that will generate sales of 1,860 units annually at a selling price of $32 each. The fixed costs are $17,900 and the variable costs per unit are $9.95. The project requires $34,000 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the 4-year life of the project. The salvage value of the fixed assets is $8,900 and the tax rate is 35 percent. What is the operating cash flow?

OCF = [1,860($32 − 9.95) − $17,900](1 − .35) + .35($34,000/4) OCF = $17,998

Rock Haven has a proposed project that will generate sales of 1,905 units annually at a selling price of $35 each. The fixed costs are $19,400 and the variable costs per unit are $11.15. The project requires $35,800 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the 4-year life of the project. The salvage value of the fixed assets is $9,500 and the tax rate is 35 percent. What is the operating cash flow?

OCF = [1,905($35 − 11.15) − $19,400](1 − .35) + .35($35,800/4) OCF = $20,055

Rock Haven has a proposed project that will generate sales of 1,920 units annually at a selling price of $36 each. The fixed costs are $19,900 and the variable costs per unit are $11.55. The project requires $36,400 of fixed assets that will be depreciated on a straight-line basis to a zero book value over the 4-year life of the project. The salvage value of the fixed assets is $9,700 and the tax rate is 40 percent. What is the operating cash flow?

OCF = [1,920($36 − 11.55) − $19,900](1 − .40) + .40($36,400/4) OCF = $19,866

All of the following are anticipated effects of a proposed project. Which of these should be considered when computing the cash flow for the final year of the project?

Operating cash flow, net working capital recovery, salvage values

You own a house that you rent for $1,250 per month. The maintenance expenses on the house average $230 per month. The house cost $225,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $247,000. If you sell the house you will incur $19,760 in real estate fees. The annual property taxes are $2,800. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

Opportunity cost = $247,000 − 19,760 Opportunity cost = $227,240

You own a house that you rent for $1,325 per month. The maintenance expenses on the house average $245 per month. The house cost $228,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $250,000. If you sell the house you will incur $20,000 in real estate fees. The annual property taxes are $2,950. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

Opportunity cost = $250,000 − 20,000 Opportunity cost = $230,000

You own a house that you rent for $1,375 per month. The maintenance expenses on the house average $255 per month. The house cost $230,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $252,000. If you sell the house you will incur $20,160 in real estate fees. The annual property taxes are $3,050. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

Opportunity cost = $252,000 − 20,160 Opportunity cost = $231,840

You own a house that you rent for $1,400 per month. The maintenance expenses on the house average $260 per month. The house cost $231,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $253,000. If you sell the house you will incur $20,240 in real estate fees. The annual property taxes are $3,100. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

Opportunity cost = $253,000 − 20,240 Opportunity cost = $232,760

You own a house that you rent for $1,450 per month. The maintenance expenses on the house average $270 per month. The house cost $233,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $255,000. If you sell the house you will incur $20,400 in real estate fees. The annual property taxes are $3,200. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

Opportunity cost = $255,000 − 20,400 Opportunity cost = $234,600

You own a house that you rent for $1,575 per month. The maintenance expenses on the house average $295 per month. The house cost $238,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $260,000. If you sell the house you will incur $20,800 in real estate fees. The annual property taxes are $3,450. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

Opportunity cost = $260,000 − 20,800 Opportunity cost = $239,200

You own a house that you rent for $1,600 per month. The maintenance expenses on the house average $300 per month. The house cost $239,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $261,000. If you sell the house you will incur $20,880 in real estate fees. The annual property taxes are $3,500. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

Opportunity cost = $261,000 − 20,880 Opportunity cost = $240,120

A project with an initial cost of $30,100 is expected to provide cash flows of $10,050, $11,200, $14,300, and $8,800 over the next four years, respectively. If the required return is 8.6 percent, what is the project's profitability index?

PI = [$10,050/(1 + .086) + $11,200/(1 + .086)2 + $14,300/(1 + .086)3 + $8,800/(1 + .086)4]/$30,100 PI = 1.204

A project with an initial cost of $30,500 is expected to provide cash flows of $10,650, $11,600, $14,700, and $9,200 over the next four years, respectively. If the required return is 9 percent, what is the project's profitability index?

PI = [$10,650/(1 + .090) + $11,600/(1 + .090)2 + $14,700/(1 + .090)3 + $9,200/(1 + .090)4]/$30,500 PI = 1.226

A project with an initial cost of $31,600 is expected to provide cash flows of $12,300, $12,700, $15,800, and $10,300 over the next four years, respectively. If the required return is 8.6 percent, what is the project's profitability index?

PI = [$12,300/(1 + .086) + $12,700/(1 + .086)2 + $15,800/(1 + .086)3 + $10,300/(1 + .086)4]/$31,600 PI = 1.324

A project with an initial cost of $31,900 is expected to provide cash flows of $12,750, $13,000, $16,100, and $10,600 over the next four years, respectively. If the required return is 8.9 percent, what is the project's profitability index?

PI = [$12,750/(1 + .089) + $13,000/(1 + .089)2 + $16,100/(1 + .089)3 + $10,600/(1 + .089)4]/$31,900PI = 1.338

A project with an initial cost of $30,000 is expected to provide cash flows of $9,900, $11,100, $14,200, and $8,700 over the next four years, respectively. If the required return is 8.5 percent, what is the project's profitability index?

PI = [$9,900/(1 + .085) + $11,100/(1 + .085)2 + $14,200/(1 + .085)3 + $8,700/(1 + .085)4]/$30,000 PI = 1.198

Which method(s) of project analysis is(are) best suited for use by a department manager who has no knowledge of time value of money but can estimate the cash flows of small projects with short lives fairly accurately?

Payback

Which one of the following is the best example of two mutually exclusive projects?

Renting out a company warehouse or selling it outright

Bubbly Waters currently sells 320 Class A spas, 470 Class C spas, and 220 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does, it can sell 395 units per year. However, if the new spa is added, Class A sales are expected to decline to 235 units while the Class C sales are expected to increase to 495. The sales of the deluxe model will not be affected. Class A spas sell for an average of $12,300 each. Class C spas are priced at $6,200 and the deluxe models sell for $17,200 each. The new mid-range spa will sell for $8,200. What annual sales figure should you use in your analysis?

Sales = 395($8,200) + (235 − 320)($12,300) + (495 − 470)($6,200) Sales = $2,348,500

Bubbly Waters currently sells 390 Class A spas, 540 Class C spas, and 290 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does, it can sell 465 units per year. However, if the new spa is added, Class A sales are expected to decline to 270 units while the Class C sales are expected to increase to 565. The sales of the deluxe model will not be affected. Class A spas sell for an average of $13,700 each. Class C spas are priced at $6,900 and the deluxe models sell for $17,900 each. The new mid-range spa will sell for $8,900. What annual sales figure should you use in your analysis?

Sales = 465($8,900) + (270 − 390)($13,700) + (565 − 540)($6,900) Sales = $2,667,000

Bubbly Waters currently sells 430 Class A spas, 580 Class C spas, and 330 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does, it can sell 505 units per year. However, if the new spa is added, Class A sales are expected to decline to 290 units while the Class C sales are expected to increase to 605. The sales of the deluxe model will not be affected. Class A spas sell for an average of $14,500 each. Class C spas are priced at $7,300 and the deluxe models sell for $18,300 each. The new mid-range spa will sell for $9,300. What annual sales figure should you use in your analysis?

Sales = 505($9,300) + (290 − 430)($14,500) + (605 − 580)($7,300) Sales = $2,849,000

Bubbly Waters currently sells 450 Class A spas, 600 Class C spas, and 350 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does, it can sell 525 units per year. However, if the new spa is added, Class A sales are expected to decline to 300 units while the Class C sales are expected to increase to 625. The sales of the deluxe model will not be affected. Class A spas sell for an average of $14,900 each. Class C spas are priced at $7,500 and the deluxe models sell for $18,500 each. The new mid-range spa will sell for $9,500. What annual sales figure should you use in your analysis?

Sales = 525($9,500) + (300 − 450)($14,900) + (625 − 600)($7,500) Sales = $2,940,000

Bubbly Waters currently sells 460 Class A spas, 610 Class C spas, and 360 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does, it can sell 535 units per year. However, if the new spa is added, Class A sales are expected to decline to 305 units while the Class C sales are expected to increase to 635. The sales of the deluxe model will not be affected. Class A spas sell for an average of $15,100 each. Class C spas are priced at $7,600 and the deluxe models sell for $18,600 each. The new mid-range spa will sell for $9,600. What annual sales figure should you use in your analysis?

Sales = 535($9,600) + (305 − 460)($15,100) + (635 − 610)($7,600) Sales = $2,985,500

Bubbly Waters currently sells 490 Class A spas, 640 Class C spas, and 390 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does, it can sell 565 units per year. However, if the new spa is added, Class A sales are expected to decline to 320 units while the Class C sales are expected to increase to 665. The sales of the deluxe model will not be affected. Class A spas sell for an average of $15,700 each. Class C spas are priced at $7,900 and the deluxe models sell for $18,900 each. The new mid-range spa will sell for $9,900. What annual sales figure should you use in your analysis?

Sales = 565($9,900) + (320 − 490)($15,700) + (665 − 640)($7,900) Sales = $3,122,000

Bubbly Waters currently sells 530 Class A spas, 680 Class C spas, and 430 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does, it can sell 605 units per year. However, if the new spa is added, Class A sales are expected to decline to 340 units while the Class C sales are expected to increase to 705. The sales of the deluxe model will not be affected. Class A spas sell for an average of $16,500 each. Class C spas are priced at $8,300 and the deluxe models sell for $19,300 each. The new mid-range spa will sell for $10,300. What annual sales figure should you use in your analysis?

Sales = 605($10,300) + (340 − 530)($16,500) + (705 − 680)($8,300) Sales = $3,304,000

Which one of these is an example of erosion that should be included in project analysis?

The anticipated loss of current sales when a new product is launched.

You are considering an investment project with an internal rate of return of 8.7 percent, a net present value of $393, and a payback period of 2.44 years. Which one of the following is correct given this information?

The discount rate used in computing the net present value was less than 8.7 percent.

How should a profitability index of zero be interpreted?

The project's cash flows subsequent to the initial cash flow have a present value of zero.

Gateway Communications is considering a project with an initial fixed assets cost of $1.58 million that will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $235,000. The project will not change sales but will reduce operating costs by $385,000 per year. The tax rate is 35 percent and the required return is 12.6 percent. The project will require $49,500 in net working capital, which will be recouped when the project ends. What is the project's NPV?

Year 0 CF = −$1,580,000 − 49,500 Year 0 CF = −$1,629,500 OCF = $385,000(1 − .35) + .35($1,580,000/10) OCF = $305,550 Year 10 CF (w/o OCF) = $49,500 + 235,000(1 − .35) Year 10 CF (w/o OCF) = $202,250 NPV = −$1,629,500 + 305,550(PVIFA12.6%,10) + 202,250/1.12610 NPV = $117,067

Gateway Communications is considering a project with an initial fixed assets cost of $1.58 million that will be depreciated straight-line to a zero book value over the 9-year life of the project. At the end of the project the equipment will be sold for an estimated $237,000. The project will not change sales but will reduce operating costs by $393,000 per year. The tax rate is 34 percent and the required return is 11.2 percent. The project will require $50,500 in net working capital, which will be recouped when the project ends. What is the project's NPV?

Year 0 CF = −$1,580,000 − 50,500 Year 0 CF = −$1,630,500 OCF = $393,000(1 − .34) + .34($1,580,000/9)' OCF = $319,069 Year 9 CF (w/o OCF) = $50,500 + 237,000(1 − .34) Year 9 CF (w/o OCF) = $206,920 NPV = −$1,630,500 + 319,069(PVIFA11.2%,9) + 206,920/1.1129 NPV = $202,140

Gateway Communications is considering a project with an initial fixed assets cost of $1.59 million that will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $236,000. The project will not change sales but will reduce operating costs by $385,500 per year. The tax rate is 40 percent and the required return is 11.1 percent. The project will require $50,000 in net working capital, which will be recouped when the project ends. What is the project's NPV?

Year 0 CF = −$1,590,000 − 50,000 Year 0 CF = −$1,640,000 OCF = $385,500(1 − .40) + .40($1,590,000/10) OCF = $294,900 Year 10 CF (w/o OCF) = $50,000 + 236,000(1 − .40) Year 10 CF (w/o OCF) = $191,600 NPV = −$1,640,000 + 294,900(PVIFA11.1%,10) + 191,600/1.11110 NPV = $156,350

Gateway Communications is considering a project with an initial fixed assets cost of $1.67 million that will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $225,000. The project will not change sales but will reduce operating costs by $380,000 per year. The tax rate is 35 percent and the required return is 9.9 percent. The project will require $45,000 in net working capital, which will be recouped when the project ends. What is the project's NPV?

Year 0 CF = −$1,670,000 − 45,000 Year 0 CF = −$1,715,000 OCF = $380,000(1 − .35) + .35($1,670,000/10) OCF = $305,450 Year 10 CF (w/o OCF) = $45,000 + 225,000(1 − .35) Year 10 CF (w/o OCF) = $191,250 NPV = −$1,715,000 + 305,450(PVIFA9.9%,10) + 191,250/1.09910 NPV = $244,357

Gateway Communications is considering a project with an initial fixed assets cost of $1.69 million that will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $230,000. The project will not change sales but will reduce operating costs by $382,500 per year. The tax rate is 40 percent and the required return is 10.5 percent. The project will require $47,000 in net working capital, which will be recouped when the project ends. What is the project's NPV?

Year 0 CF = −$1,690,000 − 47,000 Year 0 CF = −$1,737,000 OCF = $382,500(1 − .40) + .40($1,690,000/10) OCF = $297,100 Year 10 CF (w/o OCF) = $47,000 + 230,000(1 − .40)Year 10 CF (w/o OCF) = $185,000 NPV = −$1,737,000 + 297,100(PVIFA10.5%,10) + 185,000/1.10510 NPV = $118,152

Gateway Communications is considering a project with an initial fixed assets cost of $1.74 million that will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $232,000. The project will not change sales but will reduce operating costs by $383,500 per year. The tax rate is 35 percent and the required return is 10.7 percent. The project will require $48,000 in net working capital, which will be recouped when the project ends. What is the project's NPV?

Year 0 CF = −$1,740,000 − 48,000 Year 0 CF = −$1,788,000 OCF = $383,500(1 − .35) + .35($1,740,000/10) OCF = $310,175 Year 10 CF (w/o OCF) = $48,000 + 232,000(1 − .35) Year 10 CF (w/o OCF) = $198,800 NPV = −$1,788,000 + 310,175(PVIFA10.7%,10) + 198,800/1.10710 NPV = $133,836

Gateway Communications is considering a project with an initial fixed assets cost of $1.76 million that will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $234,000. The project will not change sales but will reduce operating costs by $384,500 per year. The tax rate is 34 percent and the required return is 10.9 percent. The project will require $49,000 in net working capital, which will be recouped when the project ends. What is the project's NPV?

Year 0 CF = −$1,760,000 − 49,000 Year 0 CF = −$1,809,000 OCF = $384,500(1 − .34) + .34($1,760,000/10) OCF = $313,610 Year 10 CF (w/o OCF) = $49,000 + 234,000(1 − .34) Year 10 CF (w/o OCF) = $203,440 NPV = −$1,809,000 + 313,610(PVIFA10.9%,10) + 203,440/1.10910 NPV = $117,989

Your company has a project available with the following cash flows: YearCash Flow 0−$81,000 1 21,550 2 25,100 3 30,900 4 26,050 5 19,900 If the required return is 14 percent, should the project be accepted based on the IRR?

Yes, because the IRR is 15.94 percent. 0 = −$81,000 + $21,550/(1 + IRR) + $25,100/(1 + IRR)2 + $30,900/(1 + IRR)3 + $26,050/(1 + IRR)4 + $19,900/(1 + IRR)5 IRR = .1594, or 15.94% Because the IRR is greater than the required return, accept the project.

our company has a project available with the following cash flows: YearCash Flow 0 −$80, 100 1 22,000 2 26,000 3 31,800 4 26,500 5 20,800 If the required return is 16 percent, should the project be accepted based on the IRR?

Yes, because the IRR is 17.63 percent. 0 = −$80,100 + $22,000/(1 + IRR) + $26,000/(1 + IRR)^2 + $31,800/(1 + IRR)^3 + $26,500/(1 + IRR)^4 + $20,800/(1 + IRR)^5 IRR = .1763, or 17.63% Because the IRR is greater than the required return, accept the project.

Which one of the following statements is true?

You must know the discount rate to compute the NPV but not the IRR.

Anne is considering two independent projects with 2-year lives. Both projects have been assigned a discount rate of 13 percent. She has sufficient funds to finance one or both projects. Project A costs $38,500 and has cash flows of $19,400 and $28,700 for Years 1 and 2, respectively. Project B costs $41,000, and has cash flows of $25,000 and $22,000 for Years 1 and 2, respectively. Which project, or projects, if either, should you accept based on the profitability index method and what is the correct reason for that decision?

You should only accept Project A since it is the only project with a PI greater than 1.

The discounted payback period of a project will decrease whenever the:

amount of each cash inflow is increased.

If a project has a net present value equal to zero, then:

any delay in receiving the projected cash inflows will cause the project's NPV to be negative.

The payback method:

applies mainly to projects where the actual results will be known relatively soon.

One characteristic of the payback method of project analysis is the:

bias towards liquidity.

Changes in the net working capital:

can affect the cash flows of a project every year of the project's life.

All else equal, the payback period for a project will decrease whenever the:

cash inflows are moved earlier in time.

The discounted payback method:

considers the time value of money.

A project which is designed to improve the manufacturing efficiency of a firm but will generate no additional sales revenue is referred to as a(n) _____ project.

cost-cutting

Proposed projects should be accepted when those projects:

create value for the owners of the firm.

A project's operating cash flow will increase when the:

depreciation expense increases.

The cash flow tax savings generated as a result of a firm's tax-deductible depreciation expense is called the:

depreciation tax shield.

The internal rate of return for an investment project is best defined as the:

discount rate that causes the net present value to equal zero.

The length of time required for a project's discounted cash flows to equal the initial cost of the project is called the:

discounted payback period.

The internal rate of return tends to be:

easier for managers to comprehend than the net present value.

One purpose of identifying all the incremental cash flows related to a proposed project is to:

eliminate any cost which has previously been incurred so that it can be omitted from the analysis of the project.

The annual annuity stream of payments with the same present value as a project's costs is called the project's _____ cost.

equivalent annual

A decrease in a firm's current cash flows resulting from the implementation of a new project is referred to as:

erosion costs.

An independent investment is acceptable if the profitability index (PI) of the investment is:

greater than 1.0.

The payback method of analysis:

has a timing bias.

Sunk costs include any cost that:

has previously been incurred and cannot be changed.

Assume you use all available methods to evaluate projects. If there is a conflict in the indicated accept/reject decision between two mutually exclusive projects due to the IRR-based indicator, you should:

ignore the IRR and rely on the decision indicated by the NPV method.

The top-down approach to computing the operating cash flow:

ignores all noncash items.

The changes in a firm's future cash flows that are a direct consequence of accepting a project are called _____ cash flows.

incremental

You are trying to determine whether to accept Project A or Project B. These projects are mutually exclusive. As part of your analysis, you should compute the incremental IRR by determining the:

internal rate of return for the differences in the cash flows of the two projects.

The discount rate that makes the net present value of an investment exactly equal to zero is called the:

internal rate of return.

Net working capital:

is frequently affected by the additional sales generated by a new project.

An investment is acceptable if the payback period:

is less than some pre-specified period of time.

The profitability index:

is useful as a decision tool when investment funds are limited and all available funds are allocated.

Payback is frequently used to analyze independent projects because:

it is easy and quick to calculate.

A financing project is acceptable if its internal rate of return is:

less than the discount rate.

Erosion can be explained as the:

loss of current sales due to a new project being implemented.

Project A is opening a bakery at 10 Center Street. Project B is opening a specialty coffee shop at the same address. Both projects have unconventional cash flows, that is, both projects have positive and negative cash flows that occur following the initial investment. When trying to decide which project to accept, given sufficient funding to accept either project, you should rely most heavily on the _____ method of analysis.

net present value

The difference between the present value of an investment's future cash flows and its initial cost is the:

net present value.

The term "tax shield" refers to a reduction in taxes created by:

noncash expenses.

If a firm is more concerned about the quick return of its initial investment than it is about the amount of value created, then the firm is most apt to evaluate a capital project using the _____ method of analysis.

payback

The length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment is called the:

payback period.

If you want to review a project from a benefit-cost perspective, you should use the _____ method of analysis.

profitability index

The net present value method of capital budgeting analysis does all of the following except:

provide a specific anticipated rate of return.

Net present value:

provides the means for considering the risks associated with a specific project.

Interest rates or rates of return on investments that have been adjusted for the effects of inflation are called _____ rates.

real

The increase you realize in buying power as a result of owning an investment is referred to as the _____ rate of return.

real

The discounted payback rule may cause:

some positive net present value projects to be rejected.

A cost that has already been paid, or a liability to pay that has already been incurred, is classified as a(n):

sunk cost.

No matter how many forms of investment analysis you employ:

the actual results from a project may vary significantly from the expected results.

The internal rate of return for a project will increase if:

the initial cost of the project can be reduced.

The bottom-up approach to computing the operating cash flow applies only when:

the interest expense is equal to zero.

For a tax-paying firm, the net present value of a project will increase when:

the operating cash flows increase.

If a project is assigned a required rate of return of zero, then:

the timing of the project's cash flows has no bearing on the value of the project.

Toni's Tools is comparing machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. These machines should be compared using:

their equivalent annual costs.

The elements that cause problems with the use of the IRR in projects that are mutually exclusive are referred to as the:

timing and scale problems.

The equivalent annual cost method is most useful in determining:

which one of two machines to purchase when the machines are mutually exclusive, have differing lives, and will be replaced.

The pro forma income statement for a cost reduction project:

will generally reflect no incremental sales.

A company that opts to forego bonus depreciation and instead uses the MACRS system of depreciation:

will write off the entire cost of an asset over the asset's class life.

Rossdale Flowers has a new greenhouse project with an initial cost of $316,500 that is expected to generate cash flows of $48,100 for 8 years and a cash flow of $63,500 in Year 9. If the required return is 8.6 percent, what is the project's NPV?

−$16,050.25 NPV = −$316,500 + $48,100(PVIFA8.60%, 8) + $63,500/(1 + .086)^9 NPV = −$16,050.25