# Chapter 10_Solutions_14thEdition.doc - Chapter10...

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Chapter 10Capital Budgeting Decision Criteria and Real Option ConsiderationsCHAPTER 10CAPITAL BUDGETING DECISIONCRITERIA AND REAL OPTIONCONSIDERATIONSSOLUTIONS TO PROBLEMS:1.NPV= -\$20,000 + \$3,000(PVIFA0.12,10)= - \$20,000 + \$3,000(5.650) =-\$3,050PI= \$3,000(5.650)/\$20,000 =0.85The project is not acceptable because it has a negative NPV and a PIof less than 1.0.2.a.Net Present ValueYearCash FlowsPVIF @ 12%Present Value0-\$30,0001.000-\$30,00015,0000.8934,46528,0000.7976,37639,0000.7126,40848,0000.6365,08858,0000.5674,53665,0000.5072,53573,0000.4521,3568-1,5000.404-60610-1Internal
Chapter 10Capital Budgeting Decision Criteria and Real Option ConsiderationsNet Present Value\$158b.Because the project has a positive NPV it should be accepted.c.The value of the firm, and therefore the shareholders’ wealth, isincreased by \$158 as a result of undertaking the project.3.Net investment = \$8,000NCF1-10= (R -O -Dep)(1 - T) +Dep= (0 - (-\$1,554) - \$800)(1 - .4) + \$800 = \$1,252.40\$8,000 = \$1,252.40(PVIFAi,10)PVIFAi,10= 6.388(FromTable IV, r is between 9% and 10%)(9.11%using a calculator)4.Net investment = \$375,000a.NPV = -\$375,000 + \$80,000(PVIFA0.12, 9) + [\$80,000 + \$75,000+ \$100,000(1 - 0.4)] (PVIF0.12,10)= - \$375,000 + \$80,000(5.328) + \$215,000(0.322)=\$120,470b.The project is acceptable, because its NPV is positive.c.The value of the firm, and therefore the shareholders’ wealth, isincreased by \$120,470 as a result of undertaking this project.d.The IRR of this project is18.71%using a calculator.e.The net present value calculation assumes the net cash flows arereinvested at 12%, the project’s required return.The internal rate ofreturn calculation assumes the net cash flows are reinvestedat18.71%, the project’s IRR.10-2Internal
Chapter 10Capital Budgeting Decision Criteria and Real Option Considerations5.\$12,000 = PV0(FVIF0.15,25) = PV0(32.919);PV0= \$364.536.After tax cost of net investment:\$100,000(1 - 0.4) = \$60,000NPV= -\$60,000 + \$10,000(PVIFA0.12,10)+ \$22,000(PVIFA0.12,10)(PVIF0.12,10)= -\$60,000 + \$10,000(5.650) + \$22,000(5.650)(0.322)=\$36,5257.a.Project A:\$20,000 = \$10,000(PVIFAi,4)PVIFAi,4=2.000i = 34.9%from Table IVProject B:\$20,000 = \$60,000(PVIFi,4)PVIFi,4= 0.333i = 31.6%from Table IIb.NPVA= -\$20,000 + \$10,000(3.17)= \$11,700NPVB= -\$20,000 + 60,000(0.683) =\$20,980c. Project B should be chosen because it has the higher NPV.It isassumed that the firm's reinvestment opportunities are moreaccurately represented by the firm's cost of capital than by the unique10-3Internal
Chapter 10Capital Budgeting Decision Criteria and Real Option Considerationsinternal rate of return of either project in this case.8.0%:NPV= -\$1,000 + \$6,000/(1+0)1- \$11,000/(1+0)2+ \$6,000/(1+0)3= 0100%:NPV =-\$1,000 + \$6,000/(1+1)1-\$11,000/(1+1)2+ \$6,000/(1+1)3=-1,000 + 3,000 - 2,750 + 750 =0200%:NPV=-\$1,000 + \$6,000/(1+2)1-\$11,000/(1+2)2+ \$6,000/(1+2)3=-1,000 + 2,000 - 1,222.22+ 222.22= 09.Computation of net investment:New unit cost\$29,000Plus:Installation cost:3,000Less:Proceeds from sale of old unit\$1,000Plus:Tax on gain from sale of old unit(\$1,000)(.4)400Equals:Net investment\$31,400Computation of net cash flows:Annual depreciation on new device =[\$29,000 + 3,000]/20 years] = \$1,600Net cash flows1-19= (R -O -Dep)(1 - T) +Dep= (0 -(-\$9,000) - \$1,600)(1 - 0.4) +\$1,600= \$6,04010-4Internal
Chapter 10Capital Budgeting Decision Criteria and Real Option ConsiderationsNet cash flow20= \$6,040 + salvage = \$6,040 + \$2,000(1 - 0.4)= \$7,240NPV =-\$31,400 + \$6,040(PVIFA0.12,19) + \$7,240(PVIF0.12,20)=-\$31,400 + \$6,040(7.366) + \$7,240(.104) =\$13,844Therefore, the old control device should be replaced.Note that this problemaddresses the unequal project life problem by assuming that the old devicecould be operated indefinitely, with appropriate maintenance outlays.

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Term
Spring
Professor
Nathan
Tags
NCF, NPVA, Budgeting Decision Criteria
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