1. Which of the following statements is most correct concerning a project with normal cash flows
(i.e., a cash outflow in Year 0 followed by cash inflows in all subsequent years)?
a. If the NPV of a project is positive then the payback period rule will always accept the project.
b. If the NPV of a project is negative, then the profitability index of the project will always be
greater than one.
c. If the profitability index of a project is greater than one, then the IRR will always be less than
the project’s cost of capital.
d. If the NPV of a project is zero, then the IRR of the project will be equal to the discount
rate for the project.
e. If the discount rate of a project is zero, then the project will always be accepted.
2. You are attempting to reconstruct a project analysis of a co-worker who was fired. You have
found the following information:






The IRR is 12%.
The project life is 4 years.
The initial cost is $20,000.
In years 1, 3 and 4 you will receive cash inflows of $6,000.
You know there will be a cash flow in year 2, but the amount is not in the file.
The appropriate discount rate is 10%.
What is the NPV of the project?
a. $860
First, find the missing cash flow at t=2. Use the IRR to
b. $970
make the argument that the NPV should be zero. You
c. $1,050
should get $8,227.69. Then use the discount rate (cost of
d. $2,500
capital) to find the NPV. You get $860.26
e. $3,300
3. A five-year project, if undertaken, will require an initial investment of $500,000. The expected
end-of-year cash flows are:
Year 1:
Year 2:
Year 3:
Year 4:
Year 5:
$120,000
$120,000
$150,000
$150,000
$180,000
Given a discount rate of 11.5%, what is the NPV of this project?
a.
b.
c.
d.
e.
$11,030.70
$15,399.20
$16,241.19
$13,852.98
$10,955.43
1
4. Consider the following projects, for a firm using a discount rate of 10%:
Project
NPV
IRR
PI
A
$200,000
10.20%
1.04
B
$200,000
11.00%
1.11
C
$60,000
10.02%
1.01
D
$(135,000)
9.00%
.95
If the projects are independent, which, if any, project(s) should the firm accept?
a.
b.
c.
d.
e.
A, B only
A, B, and C only
B, C, D only
A, B, C, and D
None
Use the following information to answer questions 23 to 25.
Plastico Inc. manufactures a variety of plastic cases and distributes them to retail stores like
Walmart. A survey conducted by the company revealed that plastic dvd cases are in high demand
by consumers and not many companies currently manufacture this type of product. The company
hired a consultant to determine whether or not they should undertake the manufacture of the dvd
cases. He charged the company $120,000 for his services and provided them with the following
information. The company currently has factories that are operating at full capacity and therefore
they would need to build an additional factory on land that they own valued at $400,000. Machines
and equipment would cost the company $500,000 and they would need to immediately increase
their inventory of glue and other items by $100,000. The increase in net working capital will be
recovered when the project ends in 10 years. The consultant estimated that they could sell 2 million
cases at a price of $0.40 per case each year. The company could move some of their current
employees over to the new plant. Their salaries cost the company $600,000 each year. Other
operating costs not including depreciation amount to $300,000 each year. The company would have
to take out a loan to finance the project and the consultant estimates that they would have to make
interest payments of $60,000 each year to service the loan. He also estimates that they could sell the
machine and equipment for $10,000 when the project ends. The company uses the straight line
method to calculate depreciation and has a cost of capital of 10% and a tax rate of 40%.
Record your final numerical answer to each of the following questions on the answer sheet. Show your
work on the back of the answer sheet for possible partial credit.
2
What is the initial outlay at t = 0 for the project? ___$1,000,000__________
Land=$400,000; Equipment = $500,000; increase in NWC = $100,000
What is the t = 2 incremental operating cash flow? _$320,000__
R=2,000,000(0.40) = $800,000; Costs = 300,000; D = (500,000-10000)/10 = $49,000;
OCF = (800,000-300,000)(1-0.40) + 0.4(49,000) = $319,600
What is the t = 10 incremental non operating cash flow? ___$110,000___
Recovery of NWC = $100,000; Salvage Value = $10,000. Total = $110,000
17. ABC, Inc is investigating a project with a projected year 0 cost outflow of $285,000, with
projected annual net cash flows of $90,250 in Year 1, $89,450 in Year 2, $110,300 in Year
3 and $119,400 in Year 4. The company has a cost of capital of 10%. Compute the IRR of
this project.
IRR=15.31%
18. Project X and Project Y are two mutually exclusive projects. Project X requires an initial
outlay of $37,990 and generates a net cash flow of $14,050 per year for six years. Project
Y requires an initial outlay of $51,950, and will generate cash flows of $15,450 per year for
eight years. Which project should be chosen and why? (Assume that the discount rate for
both projects is 10 percent).
NPVx=23,201.41
N=6, PV=-23,201.41, FV=0, I/Y=10, PMT(EAS)=5,327.21
NPVy=30,474.61
N=8, PV=-30,474.61, FV=0, I/Y=10, PMT(EAS)=5,712.28
Choose Y.
22. Consider a project with the following cash flows:
Year t = 0
20,000
t =1
$3,500
t=2
t=3
t=4
$12,500 $15,000 $15,000
What is he Discounted Payback Period of this project? The appropriate discount rate is 11%.
3
cash flow PV
cumulative PV
t=1
3153
3153
t=2
t=3
10145 10968
13298 24266
(20000-13298)/10968=0.611
DPP=2+0.611=2.611 years
Questions 23 - 25 are based on the following problem:
SSC is considering the design and manufacture of a new line of products that will include a
whirlpool tub. A market survey of current clients shows significant demand for such a product.
SSC spent $250,000 doing this market survey, which the company believes has contributed
significantly to their understanding of the demand for this new product, and the price that can
be charged.
The new product will require several sets of aluminum molds that will cost a total of $500,000.
These molds will be depreciated on a straight-line basis to a $100,000 salvage value over 5
years. The new product will also require $1,000,000 for additional plant and machinery. Plant
and machinery will be depreciated on a straight-line basis to a $200,000 salvage value over 5
years. The molds and all plant and equipment will be sold at the end of year 5 for salvage
value. Manufacture of the new products will require a $150,000 increase in net working
capital, which will be recovered at the end of the life of the project. All money for this project
will be borrowed from a bank and the annual interest cost on the loans is expected to be
$120,000 per year for each of the next 5 years.
SSC estimates that they will sell 3,000 whirlpool spa showers in each of the next 5 years. Each
unit is projected to sell for $1,000. Variable costs, excluding management salaries, are $500
per unit and incremental fixed costs for the manufacture these new units will be $450,000 per
year for each of the next 5 years. The new whirlpool spa showers are not expected to have any
effect on the demand or cost of existing units. The new plant and product will require the firm
to hire 2 new managers at a total annual cost of $125,000 each. A third manager, also with a
total annual cost of $125,000, will be moved from the existing product line to the new product
line. The accounting department will allocate her cost to this new project. SSC’s tax rate is 40
percent.
23. Compute the initial net cash flow for this project. ____________
24. Compute the Year 2 annual operating net cash flow for this project._____________
25. Compute the final year non-operating net cash flow for this project. ____________
4
Solution
Initial net cash flow:
Buy molds
Buy new plant and equipment
Increase in net working capital
Initial Net Cash Flow
- 500,000
-1,000,000
- 150,000
-1.650,000
Year 2 annual net cash flow:
(^Revenue - ^Variable Costs - ^Fixed Costs - ^Salaries - ^Depreciation)(1-T) + ^Depreciation
(3,000,000 – 1,500,000 – 450,000 – 250,000 – 240,000)(.60) + 240,000
= 576,000
Final Year Non-operating cash flow:
Sell molds
Sell plant and equipment
Recover net working capital
Final year non-operating NCF
100,000
200,000
150,000
450,000
5