solutionHW3 - ECONOMICS 389 – Solution of HW#4 Spring...

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Unformatted text preview: ECONOMICS 389 – Solution of HW #4 Spring 2010 1. NPV = PV- 355 , 000 = 400 , 000 1 + 0 . 12- 355 , 000 = 357 , 143- 355 , 000 = 2 , 143 Therefore, the project is worth pursuing. The project is viable as long as construction costs are less than the PV of the future cash flow, that is, as long as construction costs are less than $357,143. However, if the opportunity cost of capital is 20 percent, the PV of the $400,000 sales price is lower and NPV is negative: PV = 400 , 000 1 + 0 . 2 = 333 , 333 NPV = PV- 355 , 000 =- 21 , 667 The present value of the future cash flow is not as high when the opportu- nity cost of capital is higher. The project would need to provide a higher payoff in order to be viable in the face of the higher opportunity cost of capital. 2. The IRR is now about 8.9 percent because NPV =- 350 , 000 + 16 , 000 1 . 089 + 16 , 000 1 . 089 2 + 416 , 000 1 . 089 3 = 0 3. Year of Cost of PV Savings NPV at Year NPV Today Purchase Computer of Purchase 50 70 20 20 1 45 66 21 19.1 2 40 62 22 18.2 3 36 58 22 16.5 4 33 54 21 14.3 5 31 50 19 11.8 Purchase the new computer now. 1 4. Year 1 2 3 PV of Costs F. Cash flows 10,000 1,100 1,200 – 11,992 EAA 6,910 6,910 11,992 G. Cash flows 12,000 1,100 1,200 1,300 14,968 EAA 6,019 6,019 6,019 14,968 Machine G is the better buy. However, it’s still better to keep the old machine for 1 more year. That costs $4,300, which is less than G’s equiv- alent annual cost, $6,019. (Here I misunderstood the question in the class. There is no down payment at time zero, the two coststhe class....
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solutionHW3 - ECONOMICS 389 – Solution of HW#4 Spring...

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