1.What is a hurdle rate? How do you use it in a project evaluation?
Hurdle rate is the minimum amount of return on a project the company is willing to accept before starting a project. It is used in project evaluation to evaluate the amount of return on the project. A common method for evaluating the hurdle rate is apply the discounted cash flow method to the project, like net present value.
2.How does Teletech Corporation currently use the hurdle rate?
They used it based on the firm’s rating, beta, cost of capital, and they calculated WACC of 9.3% for the whole corporation.
3. What are Rick Phillips’s arguments for the use of the riskadjusted hurdlerate system? What are Buono’s arguments against the system?
Both arguments were discussed because the firm has two segments in the corporation with different cost of capital.
Phillips’ argument for the use of the riskadjusted hurdle rate system is to use different hurdle rate because the cost of equity for Telecommunications Services is lower than it is for the Products and Systems. With the same hurdle rate, the Telecommunications Services will gradually run out of capital while Products and Systems will have all the funds coming into the firm.
Buono’s argument for the opposition to riskadjusted hurdle rate is that multiple hurdle rates are illogical. The managers’ job should be to put the money where the returns are best. A single hurdle rate may deprive an underprofitable division of investments in order to channel more funds into a more profitable division, but that should be the aim of the process; to earn the highest absolute rate of return that the firm can get.
...Structure
A project's average net income divided by its average book value is referred to as the project's average:
A. netpresentvalue.
B. internal rate of return.
C. accounting return.
D. profitability index.
E. payback period.
The internal rate of return is defined as the:
A. maximum rate of return a firm expects to earn on a project.
B. rate of return a project will generate if the project in financed solely with internal funds.
C. discount rate that equates the net cash inflows of a project to zero.
D. discount rate which causes the netpresentvalue of a project to equal zero.
E. discount rate that causes the profitability index for a project to equal zero.
Which two methods of project analysis were the most widely used by CEO's as of 1999?
A. netpresentvalue and payback
B. internal rate of return and payback
C. netpresentvalue and average accounting return
D. internal rate of return and netpresentvalue
E. payback and average accounting return
The length of time a firm must wait to recoup, in presentvalue terms, the money it has in...
...chapter 8
Student: ____________________________________________________________
_______________
1. What is the netpresentvalue of a project with the following cash flows if the discount rate is 14 percent?
[pic]
A. $3,140.43
B. $929.90
C. $247.181
D. $1,027.67
E. $1,127.08
2. Timothy is considering an investment of $10,000. This investment is supposedly going to provide him with cash inflows of $2,500 in the first year and $6,000 a year for the following 2 years. At a discount rate of zero percent this investment has a netpresentvalue (NPV) of _____, but at the relevant discount rate of 18 percent the project's NPV is:
A. $1,500; $62.03.
B. $1,500; $79.54.
C. $4,500; $62.03.
D. $4,500; $79.54.
E. $6,000; $98.48.
3. A project has the following cash flows. What is the payback period?
[pic]
A. 2.00 years
B. 2.05 years
C. 2.30 years
D. 2.64 years
E. 2.94 years
4. Deep South Sounds would like to spend $189,000 for new sound equipment. However, the company has a major loan maturing 3 years from today and needs this money at that time to avoid bankruptcy. The sound equipment is expected to increase the cash flows by $45,000 in the first year, $92,400 in the second year, and $40,000 a year for the following 3 years. Should Deep South buy the sound equipment at this time? Why or...
...There are two Proposals. Proposal A and Proposal B. Both cost the amount of $ 60,000. The discount rate is 10%. The cash flows before depreciation and tax are as follows:
Year Proposal A Proposal B
$ $
0 (60,000) (60,000)
1 18,000 19,000
2 15,000 17,000
3 18,000 19,000
4 16,000 14,000
5 19,000 15,000
6 14,000 13,000
Evaluate the above proposals according to:
1. Pay Back Period.
2. Accounting Rate of Return (ARR)
3. Netpresentvalue method (NPV)
Proposal A is better than B, because ARR and NPV are higher than Proposal B
2. There are two Proposals. Proposal A and Proposal B. Proposal A costs $ 80,000 and Proposal B costs $ 100,000. The discount rate is 10%. The cash flows before depreciation and tax are as follows:
Year Proposal A Proposal B
$ $
1 13,000 15,000
2 15,000 14,000
3 18,000 19,000
4 16,000 16,000
5 19,000 13,000
6 14,000 13,000
7 16,000 19,000
8 20,000 15,000
9 0 18,000
10 0 17,000
Evaluate the above proposals according to:
1. ARR
2. NPV
3. Pay Back Period
We can select Proposal A, because ARR, NPV and PBP are positive and reject Proposal B
3.There are two Proposals. Proposal A and Proposal B. The discount rate...
...Time Value of Money
Exercise
1. If you invest $1000 today at an interest rate of 10% per year, how much will you have 20 years from now, assuming no withdrawals in interim?
2. a. If you invest $100 every year from the next 20 years starting one year from today and you earn interest of 10% per year, how much will you have at the end of the 20 years?
b. How much must you invest each year if you want to have $50000 at the end of the 20 years?
3. What is the presentvalue of the following cash flows at an interest rate of 10% per year? (Hints: don’t need to use the financial keys of your calculator, just dome common sense)
a. $100 received five years from now
b. $100 received 60 years from now
c. $100 received each year beginning one year from now and ending 10 years from now
d. $100 each year beginning one year from now and continuing forever
4. You want to establish a “wasting” fund, which will provide your with $1000 per year for four years, at which time the fund will be exhausted. How much must you put in the fund now if you can earn 10% interest per year?
5. You take a oneyear installment loan of $1000 at an interest rate of 12% per year (1% per month) to be repaid in 12 equal monthly payments.
a. What is the monthly payment?
b. What is the total amount of interest paid over the 12month term of the loan?
6. You are taking out a...
...Examples Of NetPresentValue (NPV), ROI and
Payback Analysis
Introduction
Terms and Definitions
NetPresentValue  Method of calculating the expected net monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time.
DiscountRate  Also known as the hurdlerate or required rate of return, is the rate that a project must achieve in order to be accepted rather than rejected.
Return on Investment – Expected income divided by the amount originally invested
Payback Analysis – The number of years needed to recover the initial cash outlay.
Formulas
NetPresentValue = (t=1..n A * (1+r)t OR (t=1..n A/ (1+r)t
Where A = Cash flow
r = Required rate of return
t = year of cash flow
n = the nth year
Return On Investment = (Discounted Benefits – Discounted Costs) / Discounted Costs
Payback Period = Years taken to repay initial outlay .
Eg. Project Z Outlay =...
...questions. Each solution should be accompanied by a brief explanation of no more than two (2) typed lines in length.
A) Cynthia is the Chief Financial Officer of Big Corporation (BC). Cynthia’s current objective is to evaluate five new projects with a total capital requirement of $6 million. All of the projects have a positive NPV. The overall capital available for new projects for the next year is $5 million. Which of the following statements about the capital budgeting process that Cynthia should employ is true?
1) Cynthia should rank the projects in increasing order of NPV and choose the highest ranked projects in order until the capital available is exhausted.
2) Cynthia should rank the projects in increasing order of internal rate of return and choose the highest ranked projects in order until the capital available is exhausted.
3) Cynthia should calculate the NPV of various combinations of projects and choose that combination that provides the highest NPV without exceeding the capital available.
4) Cynthia should rank the projects in decreasing order of NPV and choose the highest ranked projects in order until the capital available is exhausted.
Explanation: Calculating combinations of different projects will give Cynthia a better idea in which projects to invest in. NPV also provides proper rule for choosing mutually exclusive projects
B) Which of the following statements about diversification is false?
1) Diversification can be...
...assignment, Team D will formulate answers to determine what between Project A and Project B each project’s payback period, netpresentvalue, and internal rate of return. In addition, the team will give an analysis of what caused the ranking conflict and which project should be accepted and why. With a final comment, the team will describe factors Caledonia must consider if they were doing a lease versus buy.
Cash flows associated with these projects
RRR = 11%
Year PROJECT A PROJECT B 11%
0 ($100,000) ($100,000)
1 32,000
2 32,000 0
3 32,000 0
4 32,000 0
5 32,000 $200,000
NPV $18,269 $18,690
Required rate of return on these projects is 11 percent
a. What is each project’s payback period?
Year Project A Project B PresentValue (PV) @ 11% Project A Project B
0 100,000 100,000 1 100000 100,000
1 32,000 0 0.90 28828 0
2 32,000 0 0.81 25971 0
3 32,000 0 0.73 23398 0
4 32,000 0 0.66 21079 0
5 32,000 200,000 0.59 18990 118690
Project a 100000/32,000=3.125 years
Project b 100,000/200,000=0.5 There was no cash flow for the first 4 years 4+0.5=4.5 years
Project A’s payback period is 3.125 years whereas Project B is 4.5 years.
b. What is each project’s netpresentvalue?
The NPV for Project A is $18,269, whereas the NPV for Project B is $18,690
c....
...
FINC5001 Capital Market and Corporate Finance

Workshop 5 – Capital Budgeting II
1. Basic Concepts Review
a) In applying NetPresentValue, what factors do we include, and what factors do we ignore?
Use cash flows not accounting income
Ignore
* sunk costs
* financing costs
Include
* opportunity costs
* side effects
* working capital
* taxation
* inflation
2. Practice Questions
a) After spending $3 million on research, Better Mousetraps has developed a new trap. The project requires an initial investment in plant and equipment of $6 million. This investment will be depreciated straightline over five years to a value of zero, but, when the project comes to an end in five years, the equipment can in fact be sold for $500,000. The firm believes that working capital at each date must be maintained at 10% of next year's forecasted sales. Production costs are estimated at $1.50 per trap and the traps will be sold for $4 each. (There are no marketing expenses.) Sales forecasts are given in the following table. The firm pays tax at 35% and the required return on the project is 12%. What is the NPV?

Figures in 000's  
Year  0  1  2  3  4  5 
Unit Sales   500  600  1,000  1,000  600 
Revenues   2,000  2,400  4,000  4,000  2,400 ...
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