Business Finance I-FIN 315:
Homework Assignment:
1. Long-term investment decision, payback method Personal Finance Problem. Bill Williams has the opportunity to invest in project A that costs $5,900 today and promises to pay $2,100, $2,400, $2,400, $2,000 and $1,800 over the next 5 years. Or, Bill can invest $5,900 in project B that promises to pay $1,400, $1,400, $1,400, $3,600 and $4,100 over the next 5 years. (Hint: For mixed stream cash inflows, calculate cumulative cash inflows on a year-to-year basis until the initial investment is recovered.)
a. How long will it take for Bill to recoup his initial investment in project A?
b. How long will it take for Bill to recoup his initial investment in project B?
c. Using the payback period, which project should Bill choose?
d. Do you see any problems with his choice?
2. Net present value Using a cost of capital of 15%, calculate the net present value for the project shown in the following table and indicate whether it is acceptable,
Initial investment
(CF0)
−1,160,000
Year
(t)
Cash inflows
(CFt)
1
$83,000
2
$133,000
3
$187,000
4
$256,000
5
$314,000
6
$381,000
7
$273,000
8
$98,000
9
$47,000
10
$29,000
3. NPV—Mutually exclusive projects. Hook Industries is considering the replacement of one of its old metal stamping machines. Three alternative replacement machines are under consideration. The relevant cash flows associated with each are shown in the following table:
The firm’s cost of capital is 8%.
Machine A
Machine B
Machine C
Initial investment
(CF0)
$84,900
$59,700
$129,600
Year (t)
Cash inflows
(CFt)
1
$18,100
$11,900
$50,500
2
$18,100
$14,300
$30,200
3
$18,100
$15,700
$19,900
4
$18,100
$18,200
$20,400
5
$18,100
$19,600
$20,300
6
$18,100
$24,900
$30,300
7
$18,100
—
$40,000
8
$18,100
—
$49,500
a. Calculate the net present value (NPV) of each press.
b. Using NPV, evaluate the acceptability of each press.
c. Rank the presses from best to worst using NPV.
d. Calculate the profitability index (PI) for each press.
e. Rank the presses from best to worst using PI.
4. IRR—Mutually exclusive projects Bell Manufacturing is attempting to choose the better of two mutually exclusive projects for expanding the firm’s warehouse capacity. The relevant cash flows for the projects are shown in the following table: The firm’s cost of capital is 15%.
Project X
Project Y
Initial investment
(CF0)
$500,000
$350,000
Year
(t)
Cash inflows
(CFt)
1
$100,000
$150,000
2
$130,000
$110,000
3
$160,000
$115,000
4
$180,000
$60,000
5
$250,000
$70,000
a. Calculate the IRR for each of the projects. Assess the acceptability of each project on the basis of the IRRs.
5. NPV and IRR Benson Designs has prepared the following estimates for a long-term project it is considering. The initial investment is $13,820, and the project is expected to yield after-tax cash inflows of $3,000 per year for 7 years. The firm has a cost of capital of 9%.
a. Determine the net present value (NPV) for the project.
b. Determine the internal rate of return (IRR) for the project.
6. Payback, NPV, and IRR Rieger International is evaluating the feasibility of investing $89,000 in a piece of equipment that has a 5-year life. The firm has estimated the cash inflows associated with the proposal as shown in the following table. The firm has a 9% cost of capital.
Year
(t)
Cash inflows (CF)
1
$25,000
2
$20,000
3
$30,000
4
$30,000
5
$40,000
a. Calculate the payback period for the proposed investment.
b. Calculate the net present value (NPV) for the proposed investment.
c. Calculate the internal rate of return (IRR), rounded to the nearest whole percent, for the proposed investment.
d. Evaluate the acceptability of the proposed investment using NPV and IRR. What recommendation would you make relative to implementation of the project?
7. Integrative—Conflicting Rankings The High-Flying Growth Company (HFGC) has been expanding very rapidly in recent years, making its shareholders rich in the process. The average annual rate of return on the stock in the past few years has been 18%, and HFGC managers believe that 18% is a reasonable figure for the firm’s cost of capital. To sustain a high growth rate, HFGC’s CEO argues that the company must continue to invest in projects that offer the highest rate of return possible. Two projects are currently under review. The first is an expansion of the firm’s production capacity, and the second project involves introducing one of the firm’s existing products into a new market. Cash flows from each project appear in the following table:
Year
Plant expansion
Product introduction
0
−$3,400,000
−$600,000
1
$2,000,000
$375,000
2
$2,000,000
$400,000
3
$2,250,000
$350,000
4
$1,500,000
$375,000
a. Calculate the NPV for both projects. Rank the projects based on their NPVs.
b. Calculate the IRR for both projects. Rank the projects based on their IRRs.
c. Calculate the PI for both projects. Rank the projects based on their PIs