week05_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

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FINS 1613 Tutorial Answers 1 SCHOOL OF BANKING AND FINANCE FINS1613 BUSINESS FINANCE Semester 2, 2010 TUTORIAL ANSWERS WEEK 5 – Capital Budgeting: An Introduction Please note that some answers are exact when rounded to 2 or 3 decimal places because of the use of PV tables rather than calculators. Multiple-choice Questions 1. A major disadvantage of the payback period methodology is: a. It is useless as an indicator of risk b. It ignores any cash flows (in or out) that occur after the initial outlay has been repaid c. It does not take into account the time value of money d. Statements a, b and c are all correct e. Statements b and c are correct Answer is e. 2. A project has an initial cash outlay of $3,325 and subsequent cash inflows of $700 per year for the next 7 years. What is the project's payback period? a. 4.50 years b. 4.75 years c. 5.00 years d. 5.50 years e. 5.75 years Answer is b. Payback period – calculation Year 0 1 2 3 4 5 6 7 Outflow 3,325 Inflow 700 700 700 700 700 700 700 75 . 4 700 3325 0 t C C iod PaybackPer 3. A company has been offered an investment opportunity that will yield cash flows of $30,000 per year in years 1 through 4, $35,000 per year in years 5 through 9 and $40,000 in year 10. This
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FINS 1613 Tutorial Answers 2 investment will cost the firm $150,000 today and the discount rate is 10%. Assuming that cash flows occur evenly during the year, what is the payback period for this investment? a. 5.23 years b. 4.86 years c. 4.00 years d. 6.12 years e. 4.35 years Answer is b. Payback period – calculation Time Line - all CF's in `000s 0 1 2 3 4 5 6 7 8 9 10 -150 30 30 30 30 35 35 35 35 35 40 Cumulative Net Cash Flows Payback occurs sometime during year 5 -150 -120 -90 -60 -30 5 40 75 110 145 185 Mathematical solution: Year before full recovery is year 4 86 . 4 35 30 4 C UC Y iod PaybackPer 4. A project has the following cash flows: Time Cash Flow ($) 0 -3,000 1 1,000 2 1,000 3 1,000 4 1,000 Assuming that the discount rate is 10%, what is the discounted payback period? a. 3.00 years b. 3.30 years c. 3.52 years d. 3.75 years e. 4.75 years Answer is d. Discounted payback period – calculation Time Line 0 1 2 3 4 -3,000 1,000 1,000 1,000 1,000 Discounted cash flows 909.09 826.45 751.31 683.01 Cumulative Net Cash Flows Discount Payback occurs sometime during year 4 -3,000 -2,090.91 -1,264.46 -513.15 169.87 Mathematical solution: Year before full recovery is year 3
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FINS 1613 Tutorial Answers 3 75 . 3 01 . 683 15 . 513 3 C UC Y iod PaybackPer Discounted 5. Consider a project with the following expected cash flows: Time Cash Flow ($) 0 -700 million 1 200 million 2
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This note was uploaded on 09/22/2011 for the course FINS 1613 taught by Professor Drkhshim during the Three '10 term at University of New South Wales.

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week05_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

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