Chapter 8

# Chapter 8 - 1 Offshore Drilling Products Inc imposes a...

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1. Offshore Drilling Products, Inc., imposes a payback cutoff of three years for its international investment projects. Assume the company has the following two projects available. Year Cash Flow A Cash Flow B 0 –\$ 64,000 –\$ 109,000 1 26,500 28,500 2 34,400 33,500 3 28,500 25,500 4 14,500 231,000 Requirement 1: What is the payback period for each project? (Round your answers to 2 decimal places (e.g., 32.16).) Payback period Project A years Project B years Requirement 2: Should it accept either of them? Accept project A and reject project B Explanation: 1: Project A has cash flows of: Cash flows = \$26,500 + 34,400 Cash flows = \$60,900 during the first two years. The cash flows are still short by \$3,100 of recapturing the initial investment, so the payback for Project A is: Payback = 2 + (\$3,100 / \$28,500) Payback = 2.11 years Project B has cash flows of: Cash flows = \$28,500 + 33,500 + 25,500 Cash flows = \$87,500 during the first three years. The cash flows are still short by \$21,500 of recapturing the initial investment, so the payback for Project B is:

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Payback = 3 + (\$21,500 / \$231,000) Payback = 3.09 years 2: Using the payback criterion and a cutoff of 3 years, accept project A and reject project B. 2. Consider the following cash flows: Year Cash Flow 0 –\$ 34,000 1 14,600 2 17,100 3 12,000 Required: What is the IRR of the above set of cash flows? (Do not include the percent sign (%). Round your answer to 2 decimal places (e.g., 32.16).) Internal rate of return % Explanation: The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equation that defines the IRR for this project is: 0 = – \$34,000 + \$14,600/(1+IRR) + \$17,100/(1+IRR) 2 + \$12,000/(1+IRR) 3 Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 14.12% Calculator solution: CFo –\$34,000 C01 \$14,600 F01
1 C02 \$17,100 F02 1 C03 \$12,000 F03 1 IRR CPT 14.12% 3. Consider the following cash flows: Year Cash Flow 0 –\$ 34,000 1 14,100 2 17,600 3 11,500 Requirement 1: What is the NPV at a discount rate of zero percent? (Do not include the dollar sign (\$).) Net present value \$ Requirement 2: What is the NPV at a discount rate of 8 percent? (Do not include the dollar sign (\$).Round your answer to 2 decimal places (e.g., 32.16).) Net present value \$ Requirement 3: What is the NPV at a discount rate of 18 percent? (Do not include the dollar sign (\$). Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places (e.g., 32.16).) Net present value \$

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Requirement 4: What is the NPV at a discount rate of 28 percent? (Do not include the dollar sign (\$). Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places (e.g., 32.16).) Net present value \$ Explanation: 1: The NPV of a project is the PV of the outflows minus the PV of the inflows. At a zero discount rate (and only at a zero discount rate), the cash flows can be added together across time. So, the NPV of the project at a zero percent
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## This note was uploaded on 02/24/2011 for the course ACCT 416 taught by Professor Staff during the Winter '08 term at USC.

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Chapter 8 - 1 Offshore Drilling Products Inc imposes a...

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