Chapter 11 - Project Analysis and Evaluation
CHAPTER 11
PROJECT ANALYSIS AND EVALUATION
Answers to Concepts Review and Critical Thinking Questions
1.
Forecasting risk is the risk that a poor decision is made because of errors in projected cash flows.
The
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4.
If you receive 1,000 shares of each, the profit is:
Profit = 1,000($8) 1,000($5) = $3,000
Since you will only receive one-half of the shares of the oversubscribed issue, your profit will be:
Expected profit = 500($8) 1,000($5) = $1,000
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NPV is the PV of the outflows minus the PV of the inflows, so the NPV is:
NPV of the project = $1,400,000 + 1,214,285.71 = $185,714.29
The NPV is negative, so we would reject the project.
b.
Here we want to know the minimum growth rate in c
Taxes@34%
Net income
54,094
$ 105,006
The OCF for the company is:
OCF = EBIT + Depreciation Taxes
OCF = $159,100 + 126,500 54,094
OCF = $231,506
The depreciation tax shield is the depreciation times the tax rate, so:
Depreciation tax shield = tcDepreciati
The equation for the NPV of the project at a 20 percent required return is:
NPV = $138,000 + $28,500(PVIFA20%, 9) = $23,117.45
At a 20 percent required return, the NPV is negative, so we would reject the project.
We would be indifferent to the project if
19. The MIRR for the project with all three approaches is:
Discounting approach:
In the discounting approach, we find the value of all cash outflows to time 0, while any cash inflows
remain at the time at which they occur. So, the discounting the cash out
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b.
The equation for the IRR of the project is:
0 = $45,000,000 + $78,000,000/(1+IRR) $14,000,000/(1+IRR)2
From Descartes rule of signs, we know there are potentially two IRRs since the cash flows change
signs twice. From trial and error, the
CHAPTER 9
NET PRESENT VALUE AND OTHER
INVESTMENT CRITERIA
1.
To calculate the payback period, we need to find the time that the project has recovered its initial
investment. After three years, the project has created:
$1,600 + 1,900 + 2,300 = $5,800
in ca
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Now we can calculate the weighted average floatation costs for the various percentages of internally
raised equity. To find the portion of equity floatation costs, we can multiply the equity costs by the
percentage of equity raised extern
And the IRR is:
NPV = 0 = $44,002,765 + $14,531,250(PVIFAIRR%,4) + $30,325,000/(1 + IRR)5
IRR = 25.25%
If the initial NWC is assumed to be financed from outside sources, the cash flows are:
Year
0
1
2
3
4
5
Flow Cash
$44,099,439
14,531,250
14,531,250
14,5
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27. Here we have the expected return and beta for two assets. We can express the returns of the two assets
using CAPM. If the CAPM is true, then the security market line holds as well, which means all assets
have the same risk premium. Set
The project should only be undertaken if its cost is less than $37,943,787 since costs less than this
amount will result in a positive NPV.
21. The total cost of the equipment including floatation costs was:
Total costs = $15,000,000 + 850,000 = $15,850,0
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wD2 = 1.04($55,000,000)/$122,300,000 = .4677
Now we can multiply the weighted average cost of debt times one minus the tax rate to find the
weighted average aftertax cost of debt. This gives us:
RD = (1 .35)[(.5323)(.0768) + (.4677)(.0717)
c.
The approximate expected real return is the expected nominal return minus the inflation rate, so:
Approximate expected real return = .1612 .035 = .1262 or 12.62%
To find the exact real return, we will use the Fisher equation. Doing so, we get:
1 + E(Ri
$1.43 = $1.05(1 + g)4
g = .0803 or 8.03%
The cost of equity using the geometric dividend growth rate is:
RE = [$1.43(1.0803)/$45.00] + .0803 = .1146 or 11.46%
5.
The cost of preferred stock is the dividend payment divided by the price, so:
RP = $6/$96 = .
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16. To calculate the arithmetic and geometric average returns, we must first calculate the return for each
year. The return for each year is:
R1 = ($73.66 60.18 + 0.60) / $60.18 = .2340 or 23.40%
R2 = ($94.18 73.66 + 0.64) / $73.66 = .2873
c.
The average observed real return over this period was:
Average observed real return = .1122 / 8
Average observed real return = .0140 or 1.40%
d.
The statement that T-bills have no risk refers to the fact that there is only an extremely small
chance of
10. a.
This portfolio does not have an equal weight in each asset. We first need to find the return of the
portfolio in each state of the economy. To do this, we will multiply the return of each asset by its
portfolio weight and then sum the products to g
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9.
Such layoffs generally occur in the context of corporate restructurings. To the extent that the market
views a restructuring as value-creating, stock prices will rise. So, its not layoffs per se that are being
cheered on. Nonetheless, W
CHAPTER 13 B-85
Even though we are solving for the and expected return of a portfolio of one stock and the risk-free
asset for different portfolio weights, we are really solving for the SML. Any combination of this stock,
and the risk-free asset will fall
b.
Using the equation for variance, we find the variance for large company stocks over this period
was:
Variance = 1/5[(.0394 .0555)2 + (.1430 .0555)2 + (.1899 .0555)2 + (.1469 .0555)2 +
(.2647 .0555)2 + (.3723 .0555)2]
Variance = 0.053967
And the standar
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b.
c.
Under (2), if the market is not semi-strong form efficient, then this information could be used to
buy the stock cheap before the rest of the market discovers the financial statement anomaly.
Since (2) is stronger than (1), both impl
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d.
24. a.
The implicit assumption in the previous analysis is that each car depreciates by the same dollar
amount.
The cash flow per plane is the initial cost divided by the breakeven number of planes, or:
Cash flow per plane = $13,000,000
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Now that we know the product price, we can use the accounting breakeven equation to find the
depreciation. Doing so, we find the annual depreciation must be:
QA = (FC + D)/(P v)
15,500 = ($140,000 + D)/($34.61 24)
Depreciation = $24,394
We
Now we can calculate the NPV using our base-case projections. There is no salvage value or
NWC, so the NPV is:
NPVbase = $724,000 + $343,675(PVIFA15%,8)
NPVbase = $818,180.22
To calculate the sensitivity of the NPV to changes in the quantity sold, we will
The sensitivity of changes in the OCF to quantity sold is:
OCF/Q = ($968,600 940,700)/(36,000 35,000)
OCF/Q = +$27.90
The NPV at this level of sales is:
NPV = $3,200,000 $360,000 + $968,600(PVIFA13%,5) + [$360,000 + $500,000(1 .38)]/1.135
NPV = $210,439.3
CHAPTER 11
PROJECT ANALYSIS AND EVALUATION
Answers to Concepts Review and Critical Thinking Questions
1.
Forecasting risk is the risk that a poor decision is made because of errors in projected cash flows. The
danger is greatest with a new product because
And the NPV is:
NPV = $22,400,000 1,250,000 + $8,483,000(PVIFA10%,7) + 1,250,000/1.107
NPV = $18,290,244.48
So, the sensitivity of the NPV to changes in the price of the new club is:
NPV/P = ($10,841,563.69 18,290,244.48)/($750 800)
NPV/P = $148,973.62
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