Question Help

Topics: United States dollar, Net present value, ISO 4217 Pages: 4 (811 words) Published: August 28, 2008
1)The Seattle Corporation has been presented with an investment opportunity that 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 percent. What is the payback period for this investment?

Payback period

Using the even cash flow distribution assumption, the project will completely recover the initial investment after $30/$35 = 0.86 of Year 5: Payback = 4 + = 4.86 years.

2)As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

Project X Project Z
Year Cash Flow Cash Flow
0 -$100,000 -$100,000
1 50,000 10,000
2 40,000 30,000
3 30,000 40,000
4 10,000 60,000

If Denver’s cost of capital is 15 percent, which project would you choose?

NPV

Numerical solution:

Financial calculator solution (in thousands):
Project X: Inputs: CF0 = -100; CF1 = 50; CF2 = 40; CF3 = 30; CF4 = 10; I = 15.
Output: NPVX = -0.833 = -$833.

Project Z: Inputs: CF0 = -100; CF1 = 10; CF2 = 30; CF3 = 40; CF4 = 60; I = 15.
Output: NPVZ = -8.014 = -$8,014.

At a cost of capital of 15%, both projects have negative NPVs and, thus, both would be rejected.

3)The capital budgeting director of Sparrow Corporation is evaluating a project that costs $200,000, is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year. If the firm’s cost of capital is 14 percent and its tax rate is 40 percent, what is the project’s IRR?

IRR...
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