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
Net Present Value, NCF, NPVA, Budgeting Decision Criteria

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