Homework answers / question archive / Practice Set for Chapters 6 and 7 I STRONGLY ENCOURAGE YOU TO REVIEW THE END OF CHAPTER PROBLEMS AND EXCEL SOLUTIONS (ATTACHED TO THE COURSE) BEFORE ATTEMPTING THESE EXERCISES

Practice Set for Chapters 6 and 7 I STRONGLY ENCOURAGE YOU TO REVIEW THE END OF CHAPTER PROBLEMS AND EXCEL SOLUTIONS (ATTACHED TO THE COURSE) BEFORE ATTEMPTING THESE EXERCISES

Finance

Share With

---

Practice Set for Chapters 6 and 7

I STRONGLY ENCOURAGE YOU TO REVIEW THE END OF CHAPTER PROBLEMS AND EXCEL SOLUTIONS (ATTACHED TO THE COURSE) BEFORE ATTEMPTING THESE EXERCISES.  Please answer the following problems by typing the numerical solution into the space provided beneath each question. 

Part 1:

1.            The net present value and internal rate of return desirability measures for two mutually exclusive investments being considered by Stockton Corporation follow.

Year       NPV       IRR

S              161         14.60%

R             138         15.55%

Which investment should be chosen? ____R____

2.            SCA Corporation is considering investments G and H. Initial costs and year-end cash flows follow. The limiting resource that caused the two investments to be mutually exclusive can be reused. The required return is 8.75 percent.

Year       0              1              2              3              4                 5

G             -190,000               45,000   54,000   54,000            80,000         52,000

H             -95,000 35,000   25,000   66,000  

Net present value for project G_____________ Equivalent annuity for project G_________

Net present value for project H_____________ Equivalent annuity for project H_________

Which investment should be chosen? _______________

3.            We have three options in replacing our fleet of vehicles.  Option one is to use high-end vehicles that cost $95,000 dollars, require maintenance of $1,000 per year and have a salvage value of $68,000 after four years.  Option two is to use mid-value vehicles that cost $70,000, require $1,800 in maintenance each year, and have a salvage value of $50,000 after three years.  Option three is to use low-value vehicles that cost $40,000, require maintenance of $3,000 per year and can be sold for $25,000 after two years of usage.  Using a 7% cost of money please calculate the equivalent annual cost/charge for each option and recommend the best financial option. Assume year-end cash flows for simplicity. 

Equivalent annual charge for the high-end option_________

Equivalent annual charge for the mid-value option_________

Equivalent annual charge for the low-value option_________

Which option should be chosen? _______________

4.            We can remodel our existing building at a cost of $6,900,000 or build a new building at a cost of $11,000,000. The old building, after it is refurbished, would not be as efficient as the new one, and energy costs would therefore be $750,000 a year higher. The maintenance cost for the old building would be $650,000 per year but only $380,000 for the new building. The salvage value for the new building would be $6,850,000 million after its 15-year life, while the salvage value for the old building would be $4,800,000 after its 9-year life. In addition, the new building would allow our company to project a “Green Friendly” image that would result in better recruitment of clients and personnel.  It is estimated that this “Green Friendly” image would result in cost savings or increased cash flows (after tax) of $580,000 per year.  If the new building is built, the old, the old building can be sold now for $950,000 in its present condition (please read pages 208-209 for the treatment of this cash flow).  The required return for Boulder is 7.2 percent.

Net present value for keeping the old building_____________ Equivalent annuity for keeping the old building_________

Net present value for building a new building____________ Equivalent annuity for building a new building_________

Which option should be chosen? _______________

5.            An asset costs $165,000 and will generate cash benefits of $42,000 at the end of each year for eight years. Salvage values are $78,000, $68,000, $58,000, $48,000, $38,000, $28,000 and 0 at the end of years 2, 3, 4, 5, 6,7, and 8, respectively. The required return is 7.1 percent. Assuming that this asset can be replicated.

Equivalent annuity if abandoned after 8 years ______________

Equivalent annuity if abandoned after 7 years ______________

Equivalent annuity if abandoned after 6 years ______________

Equivalent annuity if abandoned after 5 years ______________

Equivalent annuity if abandoned after 4 years ______________

Equivalent annuity if abandoned after 3 years ______________

Equivalent annuity if abandoned after 2 years ______________

When is the optimal time to abandon the investment?

 Problems 6 to 12 A proposed project requiring an initial outlay of $330,000 will provide the following year-end cash flows (remember that the initial outlay and year 3 are negative cash flows)

Year       1              2              3              4              5                   6

Cash Flows          $140,000              $191,000              $-380,000             $295,000              $321,000              $265,000

6.            Using a 5.6% required return, please compute the net present value______________. Is the investment desirable?

7.            Using a 5.6% required return, please compute the profitability index for the above investment__________________.

8.            Using a 5.6% required return, please compute the modified profitability index for the above investment__________________.

9.            Please compute the internal rate of return for the above investment __________________.

10.          Using a 5.6% required return, please compute the modified internal rate of return for the above investment (using the method described in the text that take the inflows and outflows to terminal value – not the preprogramed MIRR function in Excel which bring the inflows and outflows to present values). _________________

11.          Please compute the payback period for the above investment__________________.

12.          Using a 5.6% required return, please compute the present value payback period for the above investment__________________.

Part 2:

1.            If you work at company that had limited access to the capital markets because you are small, new, or private, which method-might you prefer?           

2.            Why might the internal rate of return method give an answer in conflict with the net present value method?

3.            Assume that we are analyzing a positive net present value project. For this project, which measure would be a more conservative measure of the rate of the return – the internal rate of return or the modified internal rate of return?

4.            When you have independent projects what is the decision rule related to net present value?

5.            You have two mutually exclusive projects with the following equivalent annuities Project A with an equivalent annuity of $25,000, and Project B with an equivalent annuity of $20,000.  Which one is better? and do we need to consider risk or is this already in the equivalent annuity number?

6.            What benefit comes from calculating the equivalent annuity?

7.            Which method give the user the wealth created per dollar “committed” to the project?

8.            There is a project that involves rebuilding a machine and having the machine last for five more years and an alternative to this project which is to buy a new machine which would last for ten years.  A project like this project (or machine) is available at the end of either machine’s life – so we need to compare our alternatives using the equivalent annuity technique.  The rebuild option with a five-year life will use a present value interest factor for five years to calculate the equivalent annuity.  The new machine with a ten-year life will use a present value for ten years.  Given these unequal lives, where do you model the immediate (foregone or taken) salvage value from the sale of the existing machine? In the cash flows of the option to rebuild the machine (five-year option) or in the cash flows of the new machine option (ten-year option)?  (the answer is both important and disclosed in the chapter)

9.            What weakness remains with the present value payback method?

10.          If you calculate the profitability index and get and answer of 1.45, are you getting your dollar back and 1.45 additional dollars or are you getting your dollar back and an additional 45 cents?  Pick one.