1. Elderkin & Martin is considering an investment which will cost $200,000. The investment produces no cash
flows for the first year. In the second year, the cash inflow is $55,000. This inflow will increase to $120,000 and
then $200,000 for the following two years before ceasing permanently. The firm requires a 14 percent rate of
return and has a required discounted payback period of four years. The firm should _____ the project because the
discounted payback period is _____ years. Accept or reject this project? Why?
A. accept; 2.26
B. accept; 2.49
C.
accept; 3.65
D. reject; 3.26
E. reject; 3.96
Year
Cash
Flow
Discounted Cash
Flow
Cumulative
DCF
1
0
0
0
2
55,000
42,320.71
42,320.71
3
120,000
80,996.58
123,317.30
4
200,000
118,416.06
241,733.35
5
200,000
103,873.73
345,607.08
The remainder after 3 years is 200,000
–
123,317.30 = 76,682.70. It is covered over 76,682.70/118,416.06 = 0.65 of the year. The payback is therefore
3.65. The required payback period is higher at 4 years. Accept the project
2. You are considering the following two mutually exclusive projects. The required rate of return is 10.75 percent
for project A and 12 percent for project B. Which project should you accept and why?
A. project A; because it has the lower required rate of return
B.
project A; because its NPV is about $796 more than the NPV of project B
C. project B; because it has the larger NPV
D. project B; because it returns all its cash flows within two years
E. project B; because it is the largest sized project
NPV
A
= $14,610.09, NPV
B
= $13,814.92 therefore A has about $796 more in NPV.
3. The discounted payback period of a project will decrease whenever the: