# Year cf x cf y 0 5000 5000 1 2085 0 2 2085 0 3 2085 0

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year CF X CF Y 0 (5,000) (5,000) 1 2,085 0 2 2,085 0 3 2,085 0 4 2,085 9,677 a. Calculate the payback for both projects. b. Initially, the cost of capital is uncertain, so construct NPV profiles for the two projects (on the same graph) to assist in the analysis. The profiles cross at what cost of capital? What is the significance of that? c. It is now determined that the cost of capital for both projects is 14%. Which project should be selected? Why? d. Calculate the MIRR for both projects, using the 14% cost of capital. Answers: a. 2.4 yrs, 4 yrs; b. 10%; c. X; d. MIRR X = 19.69% 2. More practice with Cash Flow Evaluation. Cash flows for two mutually exclusive projects are shown below: year CF M CF N 0 (100) (100) 1 10 70 2 60 50 3 80 20 Both projects have a cost of capital of 10%. a. Calculate the payback for both projects. b. Calculate the NPV for both projects. c. Calculate the IRR for both projects. d. Calculate the MIRR for both projects. Answers: a. 2.4 yrs, 1.6 yrs; b. Rs.18.78, Rs.19.98; c. 18.1%, 23.56%; d. 16.5%, 16.9%; 3. Expansion Project. A machine has a cost of Rs.180. It will have a life of 3 years, and will be depreciated straight line to zero salvage value. It will result in sales revenue of Rs.200 per year and cash operating costs of Rs.110 per year. Use of the machine will require an increase in working capital of Rs.70 for the 3 years,

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243 beginning at year 0. The appropriate discount rate is 8% and the firm’s tax rate is 40%. a. Calculate the initial cash flow at time 0. b. Calculate the annual operating cash flows (they are identical each year). c. Calculate the relevant terminal cash flows at the end of year 3. d. What is the NPV for the machine? Answers: a. -250; b. 78; c. 70; d. Rs.6.58 4. Inflation adjustment : A project requires an initial investment of Rs.8,000, has a 4-year life and provides expected cash flows as follows, based on year 1 prices and costs: Annual revenue = Rs.5,000 Annual cash operating costs = Rs.2,000 Annual depreciation = Rs.2,000 Terminal cash flow = 0 Cost of capital = 14% and Tax = 30% a. Calculate the annual operating cash flows without adjusting for inflation. (Are these cash flows real or nominal?) Calculate the associated NPV. b. Adjust the cash flows to reflect the effects of inflation, which is expected to affect sales revenue and cash operating expenses at the rate of 4% annually. (Are these cash flows real or nominal?) Calculate the associated NPV. c. Which NPV is the correct one for evaluating the project? Ans: a. -Rs.133; b. Rs.202 5. Mutually Exclusive Projects with Unequal Lives . Murray’s Coffee House is trying to choose between two new coffee bean roasters. The required rate of return for either machine is 10%. Shown below are the after-tax cash flows associated with each machine: year CF X CF Y 0 (50,000) (30,000) 1 20,000 20,000 2 20,000 20,000 3 20,000 4 20,000 a. Calculate the replacement chain NPV for each project. b. Calculate the equivalent annual annuity for each project. c. Which project should be selected? Why?
244 Answers: a. RCNPV X = Rs.13,397, RCNPV Y = Rs.8,604; b. EAA X = Rs.4,226, EAA Y = Rs.2,714 6. Risk Adjustment and Project Selection. Acme Mfg is considering two projects, A & B, with cash flows as shown below: period CF A CF B 0 -50,000 -100,000 1 20,000 60,000 2 20,000 25,000 3 20,000 25,000 4 20,000 25,000 The opportunity cost of capital for A is 14 percent. The opportunity cost of

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• Spring '12
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