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Warm up Problems for Topic 5 (Capital Budgeting)
**These questions are designed to represent elementary principles, and are NOT representative of problems
that you will find on any exams.
1. Company A is considering a new piece of equipment. It will cost $6,000 and will produce cash flows of $1,000
every year for the next 12 years (the first cash flow will be exactly one year from today).
Cash Flows look like the following:
Y
e
a
r
0
1
2
3
4
5
6
7
8
9
10
11
12
(6,000)
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1a) What is the NPV if the appropriate discount rate is 10%?
You can either discount each individual cash flow, or recognize that the $1000 cash flows are just a twelve year
annuity. So,
PV=a/i [11/(1+i)
N
]
PV=1000/.1 [11/(1.1)
12
]
PV=$6814
Adding this to the original investment gives an NPV of
NPV=$6814$6000
NPV=$814
1b) What is the NPV if the appropriate discount rate is 12%?
PV=1000/.12 [11/(1.12)
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 Fall '09

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