hinsafdar

Project sequencing is best described as:

A) an investment in a project today that creates the opportunity to invest in other projects in the future.

B) arranging projects in an order such that cash flows from the first project fund subsequent projects.

C) prioritizing funds to achieve the maximum value for shareholders, given capital limitations.

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Projects are often sequenced through time so that investing in a project today may create the opportunity to invest in other projects in the future. Note that funding from the first project is not a requirement for project sequencing.

hinsafdar

The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in years 1 through 4, $35,000 per year in years 5 through 9, and $40,000 in year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10%. The payback period for this investment is closest to:

A) 4.86 years.

B) 5.23 years.

C) 6.12 years.

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Years	0	1	2	3	4	5
Cash Flows	-$150,000	$30,000	$30,000	$30,000	$30,000	$35,000

$150,000
120,000	(4 years)(30,000/year)
$30,000

With $30,000 unrecovered cost in year 5, and $35,000 cash flow in year 5; $30,000 / $35,000 = 0.86 years
4 + 0.86 = 4.86 years

hinsafdar

The process of evaluating and selecting profitable long-term investments consistent with the firm’s goal of shareholder wealth maximization is known as:

A) financial restructuring.

B) capital budgeting.

C) monitoring.

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In the process of capital budgeting, a manager is making decisions about a firm’s earning assets, which provide the basis for the firm’s profit and value. Capital budgeting refers to investments expected to produce benefits for a period of time greater than one year. Financial restructuring is done as a result of bankruptcy and monitoring is a critical assessment aspect of capital budgeting.

hinsafdar

Lincoln Coal is planning a new coal mine, which will cost $430,000 to build, with the expenditure occurring next year. The mine will bring cash inflows of $200,000 annually over the subsequent seven years. It will then cost $170,000 to close down the mine over the following year. Assume all cash flows occur at the end of the year. Alternatively, Lincoln Coal may choose to sell the site today. What minimum price should Lincoln set on the property, given a 16% required rate of return?

A) $325,859.

B) $376,872.

C) $280,913.

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The key to this problem is identifying this as a NPV problem even though the first cash flow will not occur until the following year. Next, the year of each cash flow must be property identified; specifically: CF0 = $0; CF1 = -430,000; CF2-8 = +$200,000; CF9 = -$170,000. One simply has to discount all of the cash flows to today at a 16% rate. NPV = $280,913.

hinsafdar

Which of the following statements about the discounted payback period is least accurate? The discounted payback:

A) frequently ignores terminal values.

B) method can give conflicting results with the NPV.

C) period is generally shorter than the regular payback.

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The discounted payback period calculates the present value of the future cash flows. Because these present values will be less than the actual cash flows it will take a longer time period to recover the original investment amount.

hinsafdar

An analyst has gathered the following data about a company with a 12% cost of capital:

	Project A	Project B
Cost	$15,000	$25,000
Life	5 years	5 years
Cash inflows	$5,000/year	$7,500/year

Projects A and B are mutually exclusive. What should the company do?

A) Reject A, Accept B.

B) Reject A, Reject B.

C) Accept A, Reject B.

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For mutually exclusive projects accept the project with the highest NPV. In this example the NPV for Project A (3,024) is higher than the NPV of Project B (2,036). Therefore accept Project A and reject Project B.

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If the projects are independent, what should the company do?

A) Accept A, Accept B.

B) Reject A, Reject B.

C) Accept A, Reject B.

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Project A: N = 5; PMT = 5,000; FV = 0; I/Y = 12; CPT → PV = 18,024; NPV for Project A = 18,024 − 15,000 = 3,024.
Project B: N = 5; PMT = 7,500; FV = 0; I/Y = 12; CPT → PV = 27,036; NPV for Project B = 27,036 − 25,000 = 2,036.
For independent projects the NPV decision rule is to accept all projects with a positive NPV. Therefore, accept both projects.

hinsafdar

Landen, Inc. uses several methods to evaluate capital projects. An appropriate decision rule for Landen would be to invest in a project if it has a positive:

A) profitability index (PI).

B) internal rate of return (IRR).

C) net present value (NPV).

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The decision rules for net present value, profitability index, and internal rate of return are to invest in a project if NPV > 0, IRR > required rate of return, or PI > 1.

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%.

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 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