Assignment #2 solutions
D
ISCOUNTED
P
AYBACK
B= 4.13
YEARS
A
CCEPT
BECAUSE
DPB < 4.25
(c)
Calculate the internal rate of return on each machine. Would you buy
these machines based on IRR? Explain. (3 Marks)
Answer
IRR
OF
M
ACHINE
A: 13.20 %
(PV=-126, PMT=36, FV=0, N=5, I=?)
IRR
OF
M
ACHINE
B: 16.32 %
(PV=-130, PMT=40, FV=0, N=5, I=?)
Y
ES
. B
OTH
IRR
S
ARE
GREATER
THAN
THE
COST
OF
CAPITAL
.
(d)
Machine A comes with an optional module which extends its useful life 2
more years (with the same annual cash flows of $36,000) at an additional
initial cost of $20,000. Which machine should you take after considering
this option? ( 6 Marks)
Answer
T
HE
PV
OF
THE
CF
STREAM
FROM
M
ACHINE
A
= -146 +36
X
(PVIFA 7, 10%)
= -146 + 36 × 4.8684
= $29,263.08
E
QUIVALENT
A
NNUAL
CF
FROM
A=
$29,263.08 / 4.8684 = $6,010.82
T
HE
PV
OF
THE
CF
STREAM
FROM
M
ACHINE
B= -130 + 40 × (PVIFA 5, 10%)
= -130 + 40 × 3.7908
= $21,631.47
E
QUIVALENT
A
NNUAL
CF
FROM
B=
$21,631.47 / 3.7908 = $5,707.31
C
HOSE
M
ACHINE
A.
Question 2 (10 marks)
Calculate the NPV for the following capital budgeting proposal:
$110,000 initial
cost, to be depreciated straight-line over five years to an expected salvage value
of $5,000, 35 percent tax rate, $35,000 additional annual revenues, $5,000
additional annual expense, $7,000 additional investment in working capital today
to be recovered in year 5.
Project has a 9 percent cost of capital. Assume that
the CCA is same as depreciation.
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