hinsafdar

Which of the following is the most appropriate decision rule for mutually exclusive projects?

A) Accept the project with the highest net present value, subject to the condition that its net present value is greater than zero.

B) Accept both projects if their internal rates of return exceed the firm’s hurdle rate.

C) If the net present value method and the internal rate of return method give conflicting signals, select the project with the highest internal rate of return.

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The project that maximizes the firm's value is the one that has the highest positive NPV.

hinsafdar

A firm is considering a $5,000 project that will generate an annual cash flow of $1,000 for the next 8 years. The firm has the following financial data:

• Debt/equity ratio is 50%.
• Cost of equity capital is 15%.
• Cost of new debt is 9%.
• Tax rate is 33%.

Determine the project's net present value (NPV) and whether or not to accept it.

[td=1,1,100]NPV

Accept / Reject

A) +$33 Accept

B) +$4,968 Accept

C) -$33 Reject

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First, calculate the weights for debt and equity

wd + we = 1
wd = 0.50We
0.5We + We = 1
wd = 0.333, we = 0.667

Second, calculate WACC

WACC = (wd × kd) × (1 − t) + (we × ke) = (0.333 × 0.09 × 0.67) + (0.667 × 0.15) = 0.020 + 0.100 = 0.120

Third, calculate the PV of the project cash flows

N = 8, PMT = -1,000, FV = 0, I/Y = 12, CPT PV = 4,967

And finally, calculate the project NPV by subtracting out the initial cash flow

NPV = $4,967 − $5,000 = -$33

hinsafdar

Lane Industries has a project with the following cash flows:

Year	Cash Flow
0	−$200,000
1	60,000
2	80,000
3	70,000
4	60,000
5	50,000

The project's cost of capital is 12%. The discounted payback period is closest to:

A) 2.9 years.

B) 3.9 years.

C) 3.4 years.

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The discounted payback period method discounts the estimated cash flows by the project’s cost of capital and then calculates the time needed to recover the investment.

Year	Cash Flow	Discounted Cash Flow	Cumulative Discounted Cash Flow
0	−$200,000	−$200,000.00	−$200,000.00
1	60,000	53,571.43	−146,428.57
2	80,000	63,775.51	−82,653.06
3	70,000	49,824.62	−32,828.44
4	60,000	38,131.08	5,302.64
5	50,000	28,371.30	33,673.98

discounted payback period =number of years until the year before full recovery +

hinsafdar

Edelman Enginenering is considering including an overhead pulley system in this year's capital budget. The cash outlay for the pully system is $22,430. The firm's cost of capital is 14%. After-tax cash flows, including depreciation are $7,500 for each of the next 5 years.
Calculate the internal rate of return (IRR) and the net present value (NPV) for the project, and indicate the correct accept/reject decision.

NPV

IRR

Accept/Reject

A) $15,070 14% Accept

B) $15,070 14% Reject

C) $3,318 20% Accept

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Using the cash flow keys:
CF0 = -22,430; CFj = 7,500; Nj = 5; Calculate IRR = 20%
I/Y = 14%; Calculate NPV = 3,318
Because the NPV is positive, the firm should accept the project.

hinsafdar

A company is considering the purchase of a copier that costs $5,000. Assume a cost of capital of 10 percent and the following cash flow schedule:

• Year 1: $3,000
• Year 2: $2,000
• Year 3: $2,000

Determine the project's payback period and discounted payback period.

Payback Period

Discounted Payback Period

A) 2.0 years 2.4 years

B) 2.0 years 1.6 years

C) 2.4 years 1.6 years

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Regarding the regular payback period, after 1 year, the amount to recover is $2,000 ($5,000 - $3,000). After the second year, the amount is fully recovered.The discounted payback period is found by first calculating the present values of each future cash flow. These present values of future cash flows are then used to determine the payback time period.

3,000 / (1 + .10)1 = 2,727
2,000 / (1 + .10)2 = 1,653  
2,000 / (1 + .10)3 = 1,503.

Then:

5,000 - (2,727 + 1,653) = 620
620 / 1,503 = .4.
So, 2 + 0.4 = 2.4.

hinsafdar

Tapley Acquisition, Inc., is considering the purchase of Tangent Company. The acquisition would require an initial investment of $190,000, but Tapley's after-tax net cash flows would increase by $30,000 per year and remain at this new level forever. Assume a cost of capital of 15%. Should Tapley buy Tangent?

A) No, because k > IRR.

B) Yes, because the NPV = $30,000.

C) Yes, because the NPV = $10,000.

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This is a perpetuity.
PV = PMT / I = 30,000 / 0.15 = 200,000
200,000 − 190,000 = 10,000

hinsafdar

Which of the following statements about NPV and IRR is least accurate?

A) For independent projects if the IRR is > the cost of capital accept the project.

B) The NPV method assumes that all cash flows are reinvested at the cost of capital.

C) For mutually exclusive projects you should use the IRR to rank and select projects.

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For mutually exclusive projects you should use NPV to rank and select projects.

hinsafdar

A company is considering a $10,000 project that will last 5 years.

• Annual after tax cash flows are expected to be $3,000
• Target debt/equity ratio is 0.4
• Cost of equity is 12%
• Cost of debt is 6%
• Tax rate 34%

What is the project's net present value (NPV)?

A) -$1,460.

B) $+1,245

C) +$1,460.

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First, calculate the weights for debt and equity

wd + we = 1
we = 1 − wd
wd /  we = 0.40
wd = 0.40 × (1 − wd)
wd = 0.40 − 0.40wd
1.40wd = 0.40
wd = 0.286, we = 0.714

Second, calculate WACC

WACC = (wd × kd) × (1 − t) + (we × ke) = (0.286 × 0.06 × 0.66) + (0.714 × 0.12) = 0.0113 + 0.0857 = 0.0970

Third, calculate the PV of the project cash flows

N = 5, PMT = -3,000, FV = 0, I/Y = 9.7, CPT → PV = 11,460

And finally, calculate the project NPV by subtracting out the initial cash flow

NPV = $11,460 − $10,000 = $1,460

hinsafdar

A firm is considering a $200,000 project that will last 3 years and has the following financial data:

• Annual after-tax cash flows are expected to be $90,000.
• Target debt/equity ratio is 0.4.
• Cost of equity is 14%.
• Cost of debt is 7%.
• Tax rate is 34%.

Determine the project's payback period and net present value (NPV).

Payback Period

NPV

A) 2.22 years $18,716

B) 2.43 years $18,716

C) 2.22 years $21,872

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Payback Period
$200,000 / $90,000 = 2.22 years
NPV MethodFirst, calculate the weights for debt and equity

wd + we = 1
we = 1 − wd
wd / we = 0.40
wd = 0.40 × (1 − wd)
wd = 0.40 − 0.40wd
1.40wd = 0.40
wd = 0.286, we = 0.714

Second, calculate WACC

WACC = (wd × kd) × (1 − t) + (we × ke) = (0.286 × 0.07 × 0.66) + (0.714 × 0.14) = 0.0132 + 0.100 = 0.1132

Third, calculate the PV of the project cash flows

90 / (1 + 0.1132)1 + 90 / (1 + 0.1132)2 + 90 / (1 + 0.1132)3 = $218,716

And finally, calculate the project NPV by subtracting out the initial cash flow

NPV = $218,716 − $200,000 = $18,716

hinsafdar

A company is considering the purchase of a copier that costs $5,000. Assume a cost of capital of 10 percent and the following cash flow schedule:

• Year 1: $3,000
• Year 2: $2,000
• Year 3: $2,000

Determine the project's NPV and IRR.

NPV

IRR

A) $243 20%

B) $883 20%

C) $883 15%

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To determine the NPV, enter the following:
PV of $3,000 in year 1 = $2,727, PV of $2,000 in year 2 = $1,653, PV of $2,000 in year 3 = $1,503. NPV = ($2,727 + $1,653 + $1,503) − $5,000 = 883.

You know the NPV is positive, so the IRR must be greater than 10%. You only have two choices, 15% and 20%. Pick one and solve the NPV. If it is not close to zero, then you guessed wrong; select the other one. [3000 ÷ (1 + 0.2)1 + 2000 ÷ (1 + 0.2)2 + 2000 ÷ (1 + 0.2)3] − 5000 = 46 This result is closer to zero (approximation) than the $436 result at 15%. Therefore, the approximate IRR is 20%.