Practice Problems
1. What is the net present value of a project with the following cash flows and a required return of 12 percent? Year 0 1 2 3 Cash Flow $28,900 $12,450 $19,630 $ 2,750
2.
What is the net present value of a project that has an initial cash outflow of $12,670 and the following cash inflows? The required return is 11.5 percent. Year 1 2 3 4 Cash Inflows $4,375 $ 0 $8,750 $4,100
3.
A project will produce cash inflows of $1,750 a year for four years. The project initially costs $10,600 to get started. In year five, the project will be closed and as a result should produce a cash inflow of $8,500. What is the net present value of this project if the required rate of return is 13.75 percent?
4.
You are considering the following two mutually exclusive projects. The required rate of return is 11.25 percent for project A and 10.75 percent for project B. Which project should you accept and why? Year 0 1 2 3 Project A $48,000 $18,400 $31,300 $11,700 Project B $126,900 $ 69,700 $ 80,900 $ 0
5.
You are considering two mutually exclusive projects with the following cash flows. Will your choice between the two projects differ if the required rate of return is 8 percent rather than 11 percent? If so, what should you do? Year 0 1 2 3 Project A $240,000 $ 0 $ 0 $325,000 Project B $198,000 $110,800 $ 82,500 $ 45,000
6. A project will produce an operating cash flow of $7,300 a year for three years. The initial cash investment in the project will be $11,600. The net aftertax salvage value is estimated at $3,500 and will be received during the last year of the project’s life. What is the net present value of the project if the required rate of return is 11 percent?
1
Washington State University Finance 325
7. A project is expected to create operating cash flows of $22,500 a year for three years. The initial cost of the fixed assets is $50,000. These assets will be worthless at the...
...debt to tangible net worth.
5. A measure of profitability and not shortterm liquidity is the
a. Accounts receivable turnover ratio.
b. Sales to working capital ratio.
c. Total asset turnover ratio.
d. Acidtest ratio.
6. Return on investment (ROI) is a term often used to express income earned on capital invested in a business unit. A company’s ROI would be increased if
a. Sales increased by the same peso amount as express and total assets increased.
b. Sales remained the same and expenses were reduced by the same peso amount that total assets increased.
c. Sales decreased by the same peso amount that expenses increased.
d. Sales and expenses increased by the same percentage that total assets increased.
(CMA adapted)
7. When a balance sheet amount is related to an income statement amount in computing a ration;
a. The balance sheet amount should be converted to an average for the year.
b. The income statement amount should be converted to an average for the year.
c. Both amounts should be converted to market value.
d. Comparisons with industry ratios are not meaningful.
(PhilCPA adapted)
8. Ratios are used for many purposes in financial statement analysis. In order to determine the return on investment for a company, the numerator of the fraction used should be
a. Net income.
b. Income before nonrecurring items.
c. Income before nonrecurring items and before income taxes.
d. Income before...
...NetPresentValue, IRR, and the Payback Period
Infomercial Entertainment, Inc.
In the good of days—before cable TV, fax machines, and multimedia personal computers—the
phrase,"…and now a word from our sponsor…”usually meant just that, Television commercials
were continued to thirtyand sixty—second messages, grouped together to occupy only two or
three minutes of viewing time. Occasionally, if you stayed up late enough sitting in front of the
tube, you'd see thirty minute segments on riveting topics like “How to Turn $10 Into$10 Million
by Investing in Real Estate That Nobody Wants.” Since few people—except for a few former
savings and loan executivesmanaged to stay awake through these halfhour programs, the shows
attracted little interest.
The era of the infomercial, those thirtyminute paid video advertisements devoted to selling a
particular idea or product, didn't really begin until after the 1992 presidential campaign. Following
Ross Perot's unsuccessful bid for public office, however, things started looking up for this new
marketing venue. If Perot could use the halfhour segments on late night TV to capture l 9 percent
of the popular vote, surely other advertisers could use the infomercial as a way to communicate
their message to a sleepy, yet receptive, audience.
Indeed, in the wake of the election, many Fortune500 corporations selling consumer
products were eager to take the plunge and go headtohead with Letterman on...
...
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 ...
...> P5 > P1 > P4 > P1 > P7 > P6 > P2
3)
The Internal Rate of Return definition is a discount rate that makes the NPV (netpresentvalue) of all cash flow from particular project is zero.
The NPV formula is:
where = net cash flow during the period t
= total initial investment
r = discount rate
t= number of periods
Project
P1
P2
P3
P4
P5
P6
P7
P8
IRR
10.87%
6.31%
11.33%
12.33%
11.12%
10.00%
15.26%
11.41%
As the diagram indicating, the rank of projects based on the IRR is like:
P7 > P4 > P8 > P3 > P5 > P1 > P6 > P2
4)
The rank of projects based on the NPV. And the formula is:
where = net cash flow during the period t
= total initial investment
r = discount rate
t= number of periods
a) When r = 8%,
Project
P1
P2
P3
P4
P5
P6
P7
P8
NPV(8%)
258.37
40.07
1152.42
448.82
396.65
37.04
234.66
474.84
The rank is like:
P3 > P8 > P4 > P5 > P1 > P7 > P6 > P2
b) When r = 10%
Project
P1
P2
P3
P4
P5
P6
P7
P8
NPV(10%)
73.09
85.45
393.93
228.22
129.70
0
165.4
182.98
According to the diagram shown, the rank is:
P3 > P4 > P8 > P7 > P5 > P1 > P6 > P2
c) When r = 12%
Project
P1
P2
P3
P4
P5
P6
P7
P8
NPV(12%)
90.08
128.79
173.04
30.41
92.96
35.71
99.35
72.25
Based on the diagram, the rank should be:
P7 > P4 > P6 > P1 > P8 > P5 > P2 > P3
When you get cash flows in the far future, like 15 years from now, the discount rate has more impact on the cash value, because is used as...
...cash flows to promptly recover its cost? b Will an investment generate an acceptable rate of return? c Will an investment have a positive netpresentvalue? d Will an investment have an adverse effect on the environment? 3 Which of the following is not considered when using the payback period to evaluate an investment? a The profitability of the investment over its entire life. b The annual net cash flow of the investment. c The cost of the investment. d The expected life of the investment. Use the following data for questions 4 and 5. Stone Mfg. is considering expanding operations by investing $300,000 in equipment. The equipment has a useful life of eight years, with no salvage value. Straightline depreciation is used. Stone predicts that net income will increase $37,500 per year as a result of this strategy. 4 Refer to the above data. The payback period for this investment is: a 8 years. b 4 years. c Over 13 years. d 2.5 years. 5 Refer to the above data. Return on average investment for this investment is: a 25%. b 20%. c 12 1/2%. d 15%.
CHAPTER 26 10MINUTE QUIZ B
NAME SECTION
#
Physician’s Pharmacy is considering the purchase of a copying machine which it will make available to customers at a percopy charge. The copying machine has an initial cost of $7,500, an estimated useful life of five years, and an estimated salvage value of $500. The estimated annual...
...these two currencies is 1 euro =1.3118 dollars so in order to make easier the case we will use 1.31 to round it up.
The politics of the Group related to the management of the risk of change foresee, as a rule, the coverage of the future commercial flows that you/they will have bookkeeping demonstration within 12 months and of the orders acquired (or committed in progress) to put aside from their expiration. It is reasonable to believe that the relative effect of coverage suspended in the Reserve of cash flow hedge will primarily be in relief to economic account in the following exercise.
The Group is exposed to consequential risks by the variation of the rates of change, that you/they can influence on its economic result and on the value of the clean patrimony. Particularly:
Whereas the societies of the Group sustain costs denominated in different currencies by those of denomination of the respective proceeds, the variation of the rates of change can influence the Result operational of such societies. In 2012, the general amount of the commercial flows directly statements to the risk of change you/he/she has been equivalent to 10% around of the billing. Gives the last budget of Fiat the total billing of 83 billion of euro therefore the figure that we will go to analyze is equal to 830 million of Euro.
CASE STUDY
The Group, which operates in numerous markets worldwide, is naturally exposed to market risks stemming from fluctuations in currency and...
...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.
Discount Rate  Also known as the hurdle rate 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 = $ 4000
Yearly cash flows = $2000...
...investment but low rate investment such as Tbills or bonds.
E) Which of the following is true about the NPV and IRR techniques?
1) The NPV and IRR techniques always provide the same ranking of different investment projects.
2) The NPV and IRR techniques explicitly consider the cost of capital and the time value of money.
3) All projects can have only one value for NPV and one value for IRR.
4) The NPV technique cannot provide information on how acquiring the project will contribute to shareholders’ wealth.
Explanation: NPV calculates presentvalue of investment and opportunity cost of capital and IRR takes time value of money and cost of capital into consideration as well.
F) Which of the following is false?
1) The profitability index method explicitly considers the time value of money and the firm’s cost of capital.
2) The payback period is preferred by managers since it is simple, easy to calculate, and estimates how quickly the project cash flows will return the investment in the project.
3) The disadvantages of the payback period method are that it ignores project cash flows which occur after the payback period as well as the time value of money.
4) The profitability index method always ranks all projects in the same way that the IRR method does.
Explanation: In IRR method projects are accepted if the IRR is greater then...
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