FINC 3304: Quiz 6

The Seattle Corp. is considering a new project. The firm has already paid $10,000 consulting fee for the feasibility analysis of the project. The project costs $210,000 to purchase buildings and equipment, $20,000 for shipping fee, and $20,000 for installation fee. Compute the depreciation basis of the project. $260,000 $250,000 $240,000 $230,000

$250,000 Depreciation basis= cost of project+Shipping cost+installation fees =210000+20000+20000= $250,000

A firm is considering an investment project with the following cash flows: Year 0 = -$125,000 (initial costs); Year 1= $35,000; Year 2 =$85,000; and Year 3 = $25,000; and Year 4 = $55,000. The company has an 8.8% cost of capital. Calculate the NPV for the project. $37,637 $64,264 $43,297 $55,381

$37,637 Year (i): 0, 1, 2, 3, 4 Cash flow (CFi): $125,000, $35,000, $85,000, $25,000, $55,000 Cost of capital, r = 8.8% = 0.088 NPV = CF0 + CF1/(1 + r)^1 + CF2/(1 + r)^2 + CF3/(1 + r)^3 + CF4/(1 + r)^4 NPV = -125,000 + 35,000/(1 + 0.088)^1 + 85,000/(1 + 0.088)^2 + 25,000/(1 + 0.088)^3 + 55,000/(1 + 0.088)^4 NPV = -125,000 + 35,000/1.088 + 85,000/1.183744 + 25,000/1.287913472 + 55,000/1.4012498575 NPV = -125,000 + 32,169.1176470588 + 71,806.0661764706 + 19,411.2419378435 + 39,250.673037089 NPV = $37,637.0987985 The NPV for the project is $37,637.10

A firm is considering an investment project with the following cash flows: Year 0 = -$125,000 (initial costs); Year 1= $35,000; Year 2 =$85,000; and Year 3 = $25,000; and Year 4 = $55,000. The company has an 8.8% cost of capital. Calculate the IRR for the project. 18.9% 21.7% 34.6% 26.3%

21.7% The IRR is the interest rate that makes the NPV of the project equal to zero. Excel: =IRR(A1:A5) A1:A5 is the column of all the cash flows. IRR = 21.7%

A firm is considering an investment project with the following cash flows: Year 0 = -$125,000 (initial costs); Year 1= $35,000; Year 2 =$85,000; and Year 3 = $25,000; and Year 4 = $55,000. The company has an 8.8% cost of capital. What is the project's payback? 2.67 years 2.81 years 2.20 years 3.04 years

3.04 years Year 1 cash flow : = $ 35,000/1.088 = $ 32,169.1175 Year 2 cash flow : = $ 71,806.0662 Year 3 cash flow : = $19,411.2419 Year 4 cash flow : = $ 39,2506.673 Discounted payback is : = 3 + ( 125,000 - 123,386.4256)/ $38,250.673 = 3.04 years APPARENTLY THIS IS WRONG ABOVE SO: So the discount payback = 2 + $5,000/ $25,000 = 2.2 years.

For two mutually projects, we assume their NPV profiles cross and the crossover rate is 9.3%. We assume the require rate of return is r. We use both NPV and IRR methods to analyze the two projects. Which of the following statements is most correct? If r > 8.3%, NPV and IRR methods always obtain similar decisions. If r > 9.3%, NPV and IRR methods obtain conflicting decisions. If r < 8.3%, NPV and IRR methods might obtain conflicting decisions. None of the above statement is correct.

If r < 8.3%, NPV and IRR methods might obtain conflicting decisions. EXPLANATION: When (1) r > crossover rate, NPV and IRR methods get similar decisions; (2) r < crossover rate, NPV and IRR methods may get conflicting decisions

Which of the following statements is not correct? Independent projects are defined as the cash flows of one are unaffected by the acceptance of the other. Mutually exclusive projects are defined as the cash flows of one can be adversely impacted by the acceptance of the other. The IRR approach can be used to evaluate both independent projects and mutually exclusive projects. The MIRR approach can be used to evaluate both independent projects and mutually exclusive projects.

The IRR approach can be used to evaluate both independent projects and mutually exclusive projects. EXPLANATION: The IRR approach can be used to evaluate independent projects, but not mutually exclusive projects.

What of the following statements about the IRR and MIRR methods is not correct? The IRR approach cannot be used to evaluate the projects with non-normal cash flows. The IRR approach assumes the reinvestment rate is IRR rather than WACC. The IRR approach might draw conflicting results when evaluation the mutually exclusive projects. The MIRR approach has the similar problems associated with the IRR approach.

The MIRR approach has the similar problems associated with the IRR approach. EXPLANATION: The MIRR approach has solved the problems associated with the IRR approach. IRR approach must not be used for non normal cashflow. An IRR reinvestment is considered at IRR rate. IRR might give conflicting results. MIRR is a modified version of IRR when reinvestment is assumed at a specified rate. Hence, remove the problem of IRR.

If a firm paid $30,000 for a consulting firm for the feasibility analysis of a project. The present value of all other estimated cash inflows and cash outflows which are related to this project is $5,000. Should the investment be taken? Yes No

Yes NVP>0 better than nothing.

If a project has NPV = 0, what types of following investors should have received their required rate of return from this project? Bondholders Preferred Stockholders Common Stockholders All of the above capital providers.

all of the above capital providers EXPLANATION: Since we use WACC as discount rate when we calculate NPV, all stakeholders (bondholders, preferred stockholders, common stockholders) are expected to receive their required rate of return (the minimum return to compensate the risk) when NPV = 0. Project NPV equals zero when the IRR equals the weighted average cost of capital (WACC) WACC is computed using the required rate of return of all investors, i.e. Bondholders, Preferred Stockholders and Common Stockholders. Hence, if the NPV equals zero, all the investor should have received their required rate of return The answer is - "all of the above"

NPV assumes that the reinvestment rate on cash flows is equal to the cost of capital (WACC), but MIRR assumes that the reinvestment rate on cash flows is equal to MIRR. True False

false EXPLANATION: NPV assumes that the reinvestment rate on cash flows is equal to the cost of capital (WACC), and MIRR also assumes that the reinvestment rate on cash flows is equal to WACC. Only IRR assumes that the reinvestment rate on cash flows is equal to IRR. The NPV has no reinvestment rate assumption; therefore, the reinvestment rate will not change the outcome of the project. The MIRR has a reinvestment rate assumption that assumes that the company will reinvest cash inflows at the MIRR's rate of return for the lifetime of the project