Unformatted text preview: BADM 115 – Section 11 Prof. Isabelle Bajeux‐Besnainou Fall 2008 Form B QUIZ #7 1. (3 points) A project has annual cash flows of $9,000 for the next 6 years and then $3,500 each year for the following 16 years. The IRR of this 22‐year project is 15 percent. If the firm’s WACC is 10 percent, what is the project’s NPV? ANSWER: Since the IRR is the discount rate at which the NPV of a project equals zero, the project’s inflows can be evaluated at the IRR and the present value of these inflows must equal the initial investment. Using a financial calculator enter the following: CF0 = 0; CF1 = 9000; Nj = 6; CF1 = 3500; Nj = 16; I/YR = 15. NPV = $43,069.97. Therefore, the initial investment for this project is $43,069.97. Using a calculator, the project's NPV at the firm’s WACC can now be solved. CF0 = ‐43069.97; CF1 = 9000; Nj = 6; CF1 = 3500; Nj = 16; I/YR = 10. NPV = $11,584.35 2. (3 points) Kennedy air Services is now in the final year of a project. The equipment originally cost $17 million, of which 90 percent has been depreciated. Kennedy can sell the used equipment today for $3 million, and its tax rate is 45 percent. What is the equipment’s after tax net salvage value? ANSWER: Equipment’s original cost $17,000,000 Depreciation (90%) 15,300,000 Book value $ 1,700,000 Gain on sale = $3,000,000 – $1,700,000 = $1,300,000. Tax on gain = $1,300,000(0.45) = $585,000. AT net salvage value = $3,000,000 – $585,000 = $2,415,000. 3. (4 points) A firm with a WACC of 11 percent is considering the following mutually exclusive projects: 0 1 2 3 4 5       Project A ‐$500 $80 $80 $80 $375 $375 Project B ‐$700 $375 $375 $100 $100 $90 Which project would you recommend? Explain. ANSWER: Project A: Using a financial calculator, enter the following data: CF0 = ‐500; CF1‐3 = 80; CF4‐5 = 375; I/YR = 11. Solve for NPV = $165.07. B ‐ 1 Project B: Using a financial calculator, enter the following data: CF0 = ‐700; CF1‐2 = 375; CF3‐4 = 100; CF5 = 90; I/YR = 11. Solve for NPV = $134.60. The decision rule for mutually exclusive projects is to accept the project with the highest positive NPV. In this situation, the firm would accept Project A since NPVA = $165.07 compared to NPVB = $134.60. B ‐ 2 ...
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 Fall '08
 Bajeux
 Management, NJ, mutually exclusive projects, net salvage value, Prof. Isabelle Bajeux‐Besnainou, Kennedy air Services

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