tut3solss - FINS 5514 Week 3: NPV & Other Investment...

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1 FINS 5514 Week 3: NPV & Other Investment Criteria Solutions 1.a 3 2 1 ) 085 . 1 ( 900 , 71 $ ) 085 . 1 ( 500 , 65 $ ) 085 . 1 ( 600 , 28 $ 000 , 135 $ NPV + + + + + + = ; NPV = $3,289.86 2.d Year Cash flow Discounted cash flow 1 $28,600 $26,359.45 2 $65,500 $55,639.32 3 $71,900 $56,291.09 09 . 291 , 56 $ 32 . 639 , 55 $ 45 . 359 , 26 $ 000 , 135 $ 2 payback Discounted + = = 2.94 years 3.a IRR = 9.69 percent The project should be accepted because the IRR of 9.69 percent is greater than the required return of 8.5 percent. 4.b PV = $138,289.86 02 . 1 000 , 135 $ 86 . 289 , 138 $ PI = = The project should be accepted because the PI of 1.02 is greater than 1.0. 5. d percent 89 . 18 1889 . 2 0 $ 000 , 800 , 1 $ 10 000 , 800 $ 000 , 750 $ 000 , 480 $ 000 , 390 $ 000 , 230 $ 000 , 50 $ ) 4 000 , 250 $ ( AAR = = + + + + + + + × = 6. c Net present value is the most valuable and the average accounting return is the least valuable. The IRR is better than payback from a financial viewpoint since IRR considers the time value of money. Also, it is important to note that the projects have conventional cash flows and are independent. 7. c 8. d 9. b 10. c
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2 4. When we use discounted payback, we need to find the value of all cash flows today. The value today of the project cash flows for the first four years is: Value today of Year 1 cash flow = $7,000/1.14 = $6,140.35 Value today of Year 2 cash flow = $7,500/1.14 2 = $5,771.01 Value today of Year 3 cash flow = $8,000/1.14 3 = $5,399.77 Value today of Year 4 cash flow = $8,500/1.14 4 = $5,032.68 To find the discounted payback, we use these values to find the payback period. The discounted first year cash flow is $6,140.35, so the discounted payback for an $9,500 initial cost is: Discounted payback = 1 + ($9,500 – 6,140.35)/$5,771.01 = 1.58 years For an initial cost of $14,000, the discounted payback is: Discounted payback = 2 + ($14,000 – 6,140.35 – 5,771.01)/$5,399.77 = 2.39 years Notice the calculation of discounted payback. We know the payback period is between two and three years, so we subtract the discounted values of the Year 1 and Year 2 cash flows from the initial cost. This is the numerator, which is the discounted amount we still need to make to recover our initial
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This note was uploaded on 04/11/2011 for the course FINS 5514 taught by Professor No during the Three '11 term at University of New South Wales.

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tut3solss - FINS 5514 Week 3: NPV & Other Investment...

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