BU393_Question_Bank - Comprehensive List of Problems

BU393_Question_Bank - Comprehensive List of Problems -...

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Question-bank Problems BU 393 Question Bank Capital Budgeting Criteria Question 1 In each of the following situations assume the cash flows given are after any tax implications and that a required rate of return of 16% is appropriate. a) GroLogic Ltd. will receive $1,000,000 today from Vulture Capital and pay Vulture Capital $1,800,000 in three years. Evaluate the project using the NPV, IRR and profitability index criteria and reconcile the differences in the accept/reject decisions. b) GroLogic Ltd. is considering the following two mutually exclusive Projects: Project P: Costs $50,000 and returns $70,000 one year from now. Project Q: Costs $75,000 and returns $100,000 one year from now. Rank these projects using the NPV, IRR and profitability index criteria and reconcile the differences in the rankings. Question 2 In each of the following situations assume a required rate of return of 10%. a) Calculate the NPV, IRR and profitability index of the project in the table below, show the decision and reconcile the differences between the decision rules where necessary: Project Cash Flows Year 0 Year 1 NPV IRR PI X $20,000 -$25,000 Decision: Accept or Reject b) Projects Y & Z are mutually exclusive projects. In the table provided, calculate the NPV, IRR and profitability index of each project, show the decision and reconcile the differences between the decision rules where necessary: Project Cash Flows Year 0 Year 1 NPV IRR PI Y -$10,000 $14,000 Z -$12,000 $16,500 Decision: Y or Z? Question 3 Cement Inc. needs to allocate this year’s capital expenditure budget to either construction of a new retail outlet or investment in product enhancement. The marketing department has prepared estimates of the predicted increase in sales resulting from each project. The required investment for each project is known and the life of each project is 5 years. The capital expenditure for both projects will be depreciated using the straight line method, ignoring the ½ year 1
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Question-bank Problems rule. The salvage value for the machinery used in the construction of the new outlet is $200,000 at the end of five years and the salvage value for the machinery used in the product enhancement is $50,000 at the end of five years. The required rate of return for both projects is identical to the firm’s cost of capital of 15%. The tax rate is 34%. The cash flows for both projects are shown in the following table. New Retail Outlet Year 0 1 2 3 4 5 Investment $1,300 Revenue $2,000 $2,100 $2,205 $2,315.25 $2,431.01 Expenses $1,100 $1,155 $1,212.75 $1,273.39 $1,337.06 Product Enhancement Year 0 1 2 3 4 5 Investment $950 Revenue $1,500 $1,575 $1,653.75 $1,736.44 $1,823.26 Expenses $800 $840 $882 $926.10 $972.41 (All figures in thousands) a. According to the NPV rule which project should the firm choose? b. According to the IRR rule which project should the firm choose? c. According to the PI rule which project should the firm choose? d. Are the selections based on different investment rules consistent? If the investment rules are not consistent, what causes the inconsistency? If the investment rules are not consistent, fix the ranking problem using the incremental IRR approach.
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This note was uploaded on 10/15/2011 for the course BUSINESS bu393 taught by Professor - during the Spring '11 term at Wilfred Laurier University .

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BU393_Question_Bank - Comprehensive List of Problems -...

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