Tutorial 05 Solutions 2009

Tutorial 05 Solutions 2009 - EFN406 TUTORIAL FIVE Tutorial...

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EFN406 1 TUTORIAL FIVE Tutorial 5 Questions 1. BF, page 162, Questions 1 to 6, 11 and 12. 2. BF, page 163, Problems 9 and 10. 3. Given below are the cash flows for two mutually exclusive projects, with unequal lives and replication. 0 1 2 3 4 5 A (80) 60 50 40 B (170) 80 70 60 50 40 Assume a cost of capital of 10% pa. Which project should be selected? Use: (a) annual equivalents (AE or EAV) (b) least common multiple of lives LCM (c) perpetual chain (infinite chain or infinite chain of replacement) 4. A motor vehicle costs \$20000 and is expected to have a trade-in value of \$16000 at the end of year 1, \$12000 at the end of year 2, \$8000 at the end of year 3, \$6000 at the end of year 4 and \$2000 at the end of year 5. Cost of maintenance is expected to be \$1250 pa for each of the first two years, \$1500 for the third year, \$2000 for year four and \$5000 for year five. An additional major overhaul is expected in year three costing \$1500, if the life is extended beyond three years. Opportunity cost is 15%. What is the optimal replacement period: every 1, 2, 3, 4 or 5 years? 5. Polycorp management has imposed a capital constraint on investment of \$300 million. The discount rate is ten percent pa and Polycorp has the following independent projects to choose from. All cash flows are in millions of dollars. Which projects should the firm select? What is the cost of the constraint to the firm? Project Outlay t 0 Cash Flow t 1 NPV@10% IRR A 100 120 9.09 20% B 100 119 8.18 19% D 200 236 14.55 18% E 200 228 7.27 14% F 300 354 21.82 18% Tutorial 5 Solutions 1. BF, page 162, Questions 1 to 6, 11 and 12. BF, Q1 The items that should be included are (a) and (b). The reasons for exclusion of the other items are as follows: (c)sunk cost; (d)allocated cost that is not relevant to the project; and (e)sunk cost. BF, Q2

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This note was uploaded on 09/15/2010 for the course BUSINESS 406 taught by Professor John during the Three '10 term at Queensland Tech.

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Tutorial 05 Solutions 2009 - EFN406 TUTORIAL FIVE Tutorial...

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