Lab 11 Problems
3.
Use the following information for the next four questions. Norlin Corporation is
considering an expansion project that will begin next year (Time 0). Norlin’s cost of capital is
12%. The initial cost of the project will be $250,000, and it is expected to generate the following
cash flows over its five-year life:
Year
1
2
3
4
5
$
$40,000
$60,000
$90,000
$90,000
$90,000
a.
a.
b.
c.
d.
e.
What is the payback period for the expansion project?
3.67 years
4.00 years
4.25 years
4.67 years
5.00 years
b.
a.
b.
c.
d.
e.
What is the net present value (NPV) of for the expansion project?
($45,197)
$5,871
$13,784
$25,726
$120,000
c.
a.
b.
c.
d.
e.
What is the internal rate of return (IRR) for the expansion project?
4.13%
6.50%
10.36%
12.83%
14.67%
8.5.
Olsen Engineering is considering including two pieces of equipment, a truck and an overhead
pulley system, in this year’s capital budget. The projects are independent. The cash outlay for the truck
is $22,430, and for the pulley system it is $17,100. Each piece of equipment has an estimated life of five
years. The annual after-tax cash flow expected to be provided by the truck is $7,500, and for the pulley it
is $5,100. The firm’s required rate of return is 14 percent. Calculate the IRR, the NPV, and the payback
period for each project, and indicate which project(s) should be accepted. Which would you choose if
they were mutually exclusive?
1
8.7.
Project S costs $15,000 and is expected to produce benefits (cash flows) of $4,500 per year for
five years. Project L costs $37,500 and is expected to produce cash flows of $11,100 per year for five
years.
a. Calculate the NPV, IRR, and payback period for each project, assuming a required rate of
return of 14 percent.
b. If the projects are independent, which project(s) should be selected? If they are mutually
exclusive projects, which project actually should be selected?
8.8.
The Cordell Coffee Company is evaluating the within-plant distribution system for its
new
roasting, grinding, and packing plant. The two alternatives are (1) a conveyor system with a high initial
cost but low annual operating cost and (2) several forklift trucks, which cost less but have considerably
higher operating costs. The decision to construct the plant has already been made, and the choice here
will have no effect on the overall revenues of the project. The required rate of return for the plant is nine
percent, and the projects’ expected net costs are listed in the following table:
Expected Net Cash Flows
Conveyor
Forklift
$(300,000)
$(120,000)
$ (66,000)
$ ( 96,000)
$ (66,000)
$ ( 96,000)
$ (66,000)
$ (96,000)
$ (66,000)
$ (96,000)
$ (66,000)
$ (96,000)
Year
0
1
2
3
4
5
a.
b.
What is the present value of costs for each alternative? Which method should be chosen?
What is the IRR for each alternative?
98.
What is the Equivalent Annual Annuity (EAA) of a project that has an initial outlay of
$2,500 followed by cash inflows of $1,000, $3,000 and $5,000 in years 1,2 & 3 respectively?
Assume a cost of capital of 11%. (Round to nearest $)
a.
b.
c.
d.
$1,256
$1,591
$1,838
$2,141
100. You are considering the following 2 mutually exclusive projects. Using the equivalent
annual annuity method and a cost of capital of 10%, which project should be selected? (Round to
nearest $)
Year
0
1
2
3
4
a.
b.
c.
d.
Project A
Cash Flow
(20,000)
15,000
20,000
Project B
Cash Flow
(20,000)
5,000
10,000
15,000
50,000
Project B because of an EAA of $12,060
Project A because of an EAA of $5,857
Project B because of an EAA of $38,320
Project A because of an EAA of $10,165
2
97.
The projected cash flows for two mutually exclusive projects are as follows:
Year
Project A
Project B
0
($150,000)
($200,000)
1
80,000
40,000
2
60,000
50,000
3
50,000
50,000
4
60,000
5
50,000
6
53,000
If the firm’s cost of capital is 10% and the equivalent annual annuity method is used to eliminate the
disparity between the projects’ lives, which project should be undertaken?
a. A
b. B
c. either because the difference in lives makes a comparison meaningless
d. A but the EAAs are so close that either is probably ok
The next problem is from chapter 11 and we may not have time in this lab to do it.
9.1.
You have been asked by the president of your company to evaluate the proposed acquisition of a
spectrometer for the firm’s R&D department. The equipment’s base price is $140,000, and it would cost
another $30,000 to modify it for special use by your firm. The spectrometer, which falls into the MACRS
three-year class, would be sold after three years for $60,000. (3-year MACRS recovery allowance
percentages are 33%, 45%, 15%, and 7% in years 1-4 respectively.) Use of the equipment would require
an increase in net working capital (spare parts inventory) of $8,000. The spectrometer would have no
effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs,
mainly labor. The firm’s marginal tax rate is 40 percent.
a. What is the initial investment outlay associated with this project? (That is, what is the Year 0
net cash flow?)
b. What are the incremental operating cash flows in Years 1, 2, and 3?
c. What is the terminal cash flow in Year 3?)
d. If the project’s required rate of return is 12 percent, should the spectrometer be purchased?
3
Key Lab 11 Problems
3.
a.
b.
c.
a 250 - 40 - 60 – 90 = 60. Need three years of cash flow + 60/90 of the 4th year = 3+60/90=
3.67 years
b (CF0 = –250; CF1 = 40; CF2 = 60; CF3 through CF5 = 90; I/Y = 12%; NPV = 5,871)
d Inputs same as above; IRR = 12.83%
8-5 Pulley versus Truck
Pulley system:
CF0 = -17100
CF1-CF5 = 5100
I = 14
compute NPV = $408.71
compute IRR = 14.99%
Since the cash flow is an annuity:
Payback = 17100/5100 = 3.35 years
Accept the project because NPV > $0
Truck system:
CF0 = -22430
CF1-CF5 = 7500
I = 14
compute NPV = 3318.11
compute IRR = 20%
Since the cash flow is an annuity:
Payback = 22430/7500 = 2.99 years
Accept the project because NPV > $0
If the projects were mutually exclusive you would pick the project with the highest NPV, which is the
truck.
8-7. a. Use a financial calculator
For project S:
CFo = -15000
CF1-CF5 = 4500
I/Y= 14
Compute NPV=$448.86
Compute IRR = 15.24%
Since the cash flow is an annuity:
PB = 15000/4500 = 3.3 years
For project L:
CFo = -37500
CF1-CF5 = 11100
I/Y= 14
Compute NPV=$607.2
Compute IRR = 14.67%
Since the cash flow is an annuity:
PB = 37500/11000 = 3.4 years
b. If the projects are independent, then both are acceptable because both NPVs are positive. If the
projects are mutually exclusive, then accept project L because it has the higher NPV.
8-8 Conveyor versus Forklift
Conveyor:
CF0 = -300000
CF1-CF5 = -66000
I=9
compute NPV = ($ 556717) or the Net Present Cost is $556717
compute IRR = no solution. You can't get an IRR with only negative cash flows (with just costs)
Forklift:
CF0 = -120000
CF1-CF5 = -96000
I=9
compute NPV = -493407. or the present value of cost is $493407
compute IRR = no solution. Same reason as above
4
Thus the forklift has a lower Net Present Cost by the following amount: $5556717-$493407=$63310.
To calculate an IRR the cash flows must include the inflows (returns) to the project as well as the costs.
98. ANS:
C
Calculator Steps
–2500
1000
3000
5000
11
CFo
CF1
CF2
CF3
I/Y
NPV = 4,491.73
Then: –4,491.73 PV, 3 n, 11 I/Y; Solve for PMT = $1,838 = EAA
100. ANS:
Calculator Steps:
A
Project A
–20,000
CFo
15,000
CF1
20,000
CF2
10
I/Y
NPV = 10,165
–20,000
5,000
10,000
15,000
50,000
10
Project B
CFo
CF1
CF2
CF3
CF4
I/Y
NPV = 38,230
EAA:
–10,165
PV
2
n
10
I/Y
PMT = $5,857 = EAA
–38,230
PV
4
n
10
I/Y
PMT = 12,060 = EAA
97. ANS:
D
Calculator steps ($000):
A:
NPV: CF0 = –150, CF1 = 80, CF2 = 60, CF3 = 50; NPV: I = 10
NPV = $9.880
EAA: PV = 9.880, N = 3, I/Y = 10; solve for PMT = $3.973 = EAA
B:
NPV: CF0 = –200, CF1 = 40, CF2 = 50, CF3 = 50; CF4 = 60, CF5 = 50, CF6 = 53,
NPV: I = 10
NPV = $17.196
EAA: PV = 17.196, N = 6, I/Y = 10; solve for PMT = $3.948 = EAA
Project A has the higher EAA, but only by $3973 – $3948 = $25
9-1. See spreadsheet key
5