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Capital Budgeting Solutions2

# Capital Budgeting Solutions2 - E 11.44 TV...

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Old Exam Questions - Capital Budgeting - Solutions Page 11 of 96 Pages * E. 11.44% TV = (\$180)(1.10) 3 + (\$170)(1.10) 2 + (\$160)(1.10) 1 + (\$150)(1.10) 0 = \$771.28 CF 0 = -\$500.00 CF 1 = \$ 0.00 CF 2 = \$ 0.00 CF 3 = \$ 0.00 CF 4 = \$771.28 Solve for MIRR = 11.44% Alternatively, N = 4 PV = -\$500.00 PMT = \$0.00 FV = \$771.28 Solve for I/YR = 11.44% 6. What is the net present value of Project A if you assume infinite replication and use the Equivalent Annual Annuity approach to determine NPV? A. \$87.25 B. \$80.12 * C. \$84.51 D. \$76.94 E. \$91.86 CF 0 = -\$500.00 CF 1 = \$180.00 CF 2 = \$170.00 CF 3 = \$160.00 CF 4 = \$150.00 I/YR = 10% NPV = \$ 26.79 Solve for EAA: N = 4 I/YR = 10% PV = \$26.79 FV = \$0.00 Solve for PMT = \$8.451 = EAA NPV A Under Infinite Replication = \$8.451 / .10 = \$84.51

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Old Exam Questions - Capital Budgeting - Solutions Page 12 of 96 Pages 7. Your company is thinking about taking on an investment project that will require an initial outlay of \$2,000,000 at time period zero. You believe that this project will produce expected after-tax cash flows of \$480,000 each year for 6 years (Years 1-6). Given a cost of capital for this project of 8 percent, you can calculate that the expected NPV for this project is \$218,982.24 and its IRR is 11.53 percent. Assume now that the firm has the option of delaying the start of this project for 1 year. If they delay the project its cost at Year 1 will increase to \$2,250,000. The firm will also have better information about what the cash flows will actually be in Years 2-7 (still a 6-year project). Specifically, there is a 50 percent probability that the cash flow will be \$280,000, and a 50 percent chance that the cash flow would be \$680,000. Ignoring option pricing, what is the incremental NPV that will arise, as of time period zero, if the firm delays implementation of this project for 1 year? * As of Time Period 1 : NPV CF Option 1 = -\$2,250,000 + [\$280,000][PVIFA 8%,6 ] = - \$955,593.69 (will not take on project) NPV CF Option 2 = -\$2,250,000 + [\$680,000][PVIFA 8%,6 ] = \$893,558.17 (will take on project) Expected NPV if Delayed = (.50)(\$0.00) + (.50)(\$893,558.17) = \$446,779.09 As of Time Period 0 : Expected NPV if Delayed = (\$446,779.09) / (1.08) = \$413,684.34 Incremental NPV = \$413,684.34 - \$218,982.24 = \$194,702.10 8. The cash flows associated with a project can be represented by the following decision tree (conditional probabilities are in parentheses): Year 0 Year 1 Year 2 Year 3 \$ 0 (.5) \$100 (.5) \$200 (.5) \$200 (.5) \$200 (.5) \$300 (.5) \$400 (.5) -\$400
Old Exam Questions - Capital Budgeting - Solutions Page 13 of 96 Pages \$400 (.5) \$500 (.5) \$600 (.5) \$600 (.5) \$600 (.5) \$700 (.5) \$800 (.5) What is the expected NPV for this project if the appropriate cost of capital is 10 percent? * After calculating expected cash flows for each year, NPV will be equal to: -\$400 + \$400 / (1.10) 1 + \$400 / (1.10) 2 + \$400 / (1.10) 3 = \$594.74 Alternatively, CF 0 = -\$400.00 CF 1 = \$400.00 CF 2 = \$400.00 CF 3 = \$400.00 I/YR = 10% Solve for NPV = \$594.74 Alternatively, N = 3 I/YR = 10 PMT = \$400.00 FV = \$0.00 Solve for PV = \$994.74 Solve for NPV = \$994.74 - \$400.00 = \$594.74

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Capital Budgeting Solutions2 - E 11.44 TV...

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