6. Calculating NPV. Suppose the firm uses the NPV decision rule. At a required return of 10 percent, should the firm accept this project? What if the required return was 21 percent?
Year 0 Cash Flow = -$145,000
Year 1 Cash Flow = $71,000
Year 2 Cash Flow = $68,000
Year 3 Cash Flow = $ 52,000
7. Calculating NPV and IRR. A project that provides annual cash flows of $2,150 for nine years costs $8,900 today. Is this a good project if the required return is 8 percent? What if it’s 24 percent? At what discount rate would you be indifferent between accepting the project and rejecting it?
15. Comparing Investment Criteria. Consider the following two mutually exclusive projects:
Cash Flow A Cash Flow B
Year 0 Cash Flow = - $415,000 Cash Flow = -$35,000
Year 1 Cash Flow = 49,000 Cash Flow = 19,400
Year 2 Cash Flow = 57,000 Cash Flow = 14,300
Year 3 Cash Flow = 74,000 Cash Flow = 13,600
Year 4 Cash Flow = 530,000 Cash Flow = 10,400
Whichever project you choose, if any, you require a 13 percent return on your investment.
a) If you apply the payback criterion, which investment will you choose? Why?
b) If you apply the NPV criterion, which investment will you choose? Why?
c) If you apply the IRR criterion, which investment will you choose? Why?
d) If you apply the profitability index criterion, which investment will you choose? Why?
e) Based on your answers in (a) through (d), which project will you finally choose? Why?
16. NPV and IRR. Higher Ground Company is presented with the following two mutally exclusive projects. The required return for both projects is 15 percent.
Year Project M Project N
Year 0 -$145,000 -$350,000
Year 1 63,000 155,000
Year 2 81,000 175,000
Year 3 72,000 140,000
Year 4 58,000 105,000
a) What is the IRR for each project?
b) What is the NPV for each project?
c) Which, if either, of the projects should the company accep?
1. Relevant Cash Flows. Kenny, Inc., is looking at setting up a new manufacturing plant in South Park. The company bought some land six years ago for $7 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent facilities elsewhere. The land would net $9.8 million if it were sold today. The company now wants to build its new manufacturing plant on this land; the plant will cost $21 million to build, and the site requires $850,00 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? Why?
9. Calculating Project OCF. Cochrane, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.1 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,150,000 in annual sales, with costs of $1,140,000. If the tax rate is 35 percent, what is the OCF for this project?
10. Calculating Project NPV. In the previous problem, suppose the required return on the project is 14 percent. What is the project’s NPV?
24. Project Analysis. McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $730 per set and have a variable cost of $360 per set. The company has spent $150,000 for a marketing study that determined the company will sell 75,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 8,500 sets per year of its high-priced clubs. The high-priced clubs sell at $1,200 and have variable costs of $540. The company will also increase sales of its cheap clubs by 11,000 sets per year. The cheap clubs sell for $340 and have variable costs of $125 per set. The fixed costs each year will be $11,200,000. The company has also spent $1,000,000 on research and development for the new clubs. The plant and equipment required will cost $24,500,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,500,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 14 percent. Calculate the payback period, the NPV, and the IRR.
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