- Calculate the net present value and profitability index of a project with a net investment of $20,000 and expected net cash flows of $3,000 a year for 10 years. if the project’s required return is 12%. Is the project acceptable?
NPV = -$20,000 + $3,000(PVIFA0.12,10)
= - $20,000 + $3,000(5.650) = -$3,050
PI = $3,000(5.650)/$20,000 = 0.85
The project is not acceptable because it has a negative NPV and a PI of less than 1.0.
2. A firm wishes to bid on a contract that is expected to yield the following after-tax net cash flows at the end of each year:
Year Net Cash Flow
1 $5,000
28,000
39,000
48,000
58,000
65,000
73,000
8$-1,500
To secure the contract, the firm must spend $30,000 to retool its plant. This retooling will have no salvage value at the end of the 8 years. Comparable investment alternatives are available to the firm that earns 12 percent compounded annually. The depreciation tax benefit from the retooling is reflected in the net cash flows in the table.
a.Compute the project's net present value
Year Cash Flows PVIF @ 12% Present Value
0 -$30,000 1.000 -$30,000
1 5,000 0.893 4,465
2 8,000 0.797 6,376
3 9,000 0.712 6,408
4 8,000 0.636 5,088
5 8,000 0.567 4,536
6 5,000 0.507 2,535
7 3,000 0.452 1,356
8 -1,500 0.404 -606
Net Present Value $158
b.Should the project be adopted?
Because the project has a positive NPV it should be accepted
c.What is the meaning of the computed net present value figure?
The computed net present value is an indication that the value of the firm, and therefore the shareholders’ wealth, is increased by $158 as a result of undertaking the project.
6. Two mutually exclusive investment projects have the following forecasted cash flows
Year AB
0 $-20,000 $-20,000
1 10,000 0
2 10,000 0
310,000&nb sp;0
410,000&nb sp;60,000
a. Compute the internal rate of return for each project,
Project A: $20,000 = $10,000(PVIFAi,4)
PVIFAi,4 = 2.000
i = 34.9% from Table IV
Project B: $20,000 = $60,000(PVIFi,4)
PVIFi,4 = 0.333
i = 31.6% from Table II
b. Compute the net present value for each project if the firm has a 10% cost of capital
NPVA = -$20,000 + $10,000(3.17) = $11,700
NPVB = -$20,000 + 60,000(0.683) = $20,980
c. Which project should be adopted and why?
Project B should be chosen because it has the higher NPV. It is assumed that the firm's reinvestment opportunities are more accurately represented by the firm's cost of capital than by the unique internal rate of return of either project in this case.
9. A junior executive is fed up with his boss's operating policies. Before leaving the office of his angered superior, the young man suggests that a well-trained monkey could handle the trivia assigned to him. Pausing a moment to consider the import of this closing statement, the boss is seized by the thought that this must have been in the back of her own mind ever since she hired the junior executive. She decides to consider replacing the executive with a bright young baboon. She figures that she could argue strongly to the board that such "capital deepening" is necessary for the cost-conscious firm. Two days later, a feasibility study is completed, and the following data are presented to the president:
* It would cost $12,000 to purchase and train a reasonably alert baboon with a life expectancy of 20 years.
* Annual expenses of feeding and housing the baboon would be $4,000.
*The junior executive's annual salary is $7,000 (a potential saving if the baboon is hired).
* The baboon will be depreciated on a straight-line basis over 20 years to a zero balance.
* The firm's marginal tax rate is 40 percent.
* The firm's current cost of capital is estimated to be 11 percent.
On the basis of the net present value criterion, should the monkey be hired (and the junior executive fired)?
Net investment (cost of baboon) = $12,000
Annual depreciation on baboon = $12,000 /20 years
= $600
Net cash flow calculation:
NCF1-20 = (R - O - Dep)(1 - T) + Dep
= (0 - ($4,000 - $7,000) - 600)(1 - .4) + 600 = $2,060/year
NPV = - $12,000 + $2,040(7.963) = $4,245
Yes, buy the baboon, since NPV > 0.
13. Note the following information on two mutually exclusive projects under consideration by Wang Food Markets, Inc.
Year AB
0 $-30,000 $-60,000
1 10,00020,000
210,000&nb sp;20,000
310,000&nb sp;20,000
410,000 20,000
510,000&nb sp;20,000
Wang requires a 14 percent rate of return on projects of this nature.
a. Compute the Net Present Value (NPV) for both projects.
NPVA = -$30,000 + $10,000(3.433) = $4,330
NPVB = -$60,000 + $20,000(3.433) = $8,660
b. Compute the internal rate of return on both projects.
IRRA: $30,000 = $10,000(PVIFAr,5)
PVIFAr,5= 3.000
From Table IV, IRRA = 20% (19.86% by calculator)
IRRB: $60,000 = $20,000(PVIFAr,5)
PVIFAr,5= 3.000
From Table IV, IRRB = 20% (19.86% by calculator)
c. Compute the profitability index of both projects.
PIA = $34,330/$30,000 = 1.14
PIB = $68,660/$60,000 = 1.14
d. Compute the payback periods for both projects.
PBA= 3 years
PBB= 3 years
e. Which of the two projects, if either, should Wang accept and why?
Wang should accept project B because its NPV is positive and higher than the NPV of project A.
16. Benford, Inc. is planning to open a new sporting goods store in a suburban mall. Benford will lease the needed space in the mall. Equipment and fixtures for the store will cost $200,000 and be depreciated over a 5-year period on a straight-line basis to $0. The new store will require Benford to increase its net working capital by $200,000 at time 0; thereafter, net working capital balances are expected to equal 20 percent of the following year's sales. First-year sales are expected to be $1 million and to increase at an annual rate of 8 percent over the expected 10-year life of the store. Operating expenses (including lease payments and excluding depreciation) are projected to equal 70 percent of sales. The salvage value of the store's equipment and fixtures is anticipated to be $10,000 at the end of 10 years. Benford's marginal tax rate is 40 percent.
A. Calculate the store's net present value, using an 18 percent required return.
B. Should Benford accepts the project?
C. Calculate the store's internal rate of return
D. Calculate the store's profitability index.
Please check the attached excel sheet
17. Consider a 2-year project with the following information: initial fixed asset investment = $495,000; straight-line depreciation to zero over the 2-year life; zero salvage value; selling price =$39; variable costs = $20; fixed costs = $210,000; quantity sold = 150,000 units; tax rate = 31 percent. How sensitive is Operating Cash Flow (OCF) to changes in quantity sold? State your answer in terms of a dollar amount change (increase or decrease) in OCF for every additional unit sold.
OCF will change by ±$13.11 for each 1 unit change in sales
Please see the attached excel sheet for calculations