Al Imam Mohammad Ibn Saud Islamic University
College of Economics and Administrative Sciences
Department of Finance and Investment
Level 4: All branches
Investment Decision Under Certainty
Exercise 1
A project has an initial outlay of $10000 and expected cash flows of $2000 at the end
of each year for the next 7 years. If the required rate of return is 12%, what is the
project’s NPV?
Exercise 2
You are considering an investment in two projects, A and B. both projects have an
initial cash outlay of $50 000 and the projected cash flows are as follows:
Year
0
1
2
3
4
5
Project A
(50 000)
20 000
25 000
30 000
35 000
40 000
Project B
(50 000)
35 000
30 000
25 000
20 000
15 000
Assuming that the cost of capital (discount rate) is 15%:
1- Calculate the payback period, discounted payback period, NPV, PI, IRR
for each project.
2- If the projects are mutually exclusive, which project should be selected?
Exercise 3
You are considering an investment in two projects mutually exclusive, A and B. both
projects have an initial cash of $ 100 000 and the projected cash flows are as follows:
Year
0
1
2
3
4
5
Project A
(100000)
40000
40000
40000
40000
40000
1
Project B
(100000)
10000
20000
40000
70000
90000
For simplicity, it will be assumed that both projects will be depreciated on linear
method over 5 years. For such projects, the average net income equal to 20000 (for
project A) and 26000 (for project B); The firm uses benchmark ARR of 28%;
Benchmark payback period of 3.5 years; Benchmark discounted payback period
of4.25 years and cost of capital of 15%.
1- Calculate the Accounting Rate of Return (ARR) for each project. Which
project should be selected?
2- Calculate the payback period for each project. Which project should be
selected?
3- Calculate the discounted payback period for each project. Which project
should be selected?
4- Calculate the Net Present Value (NPV) for each project. Which project should
be selected?
5- Calculate the Internal Rate of Return (IRR) for each project. Which project
should be selected?
6- Calculate the Profitability Index (PI) for each project. Which project should be
selected.
Exercise4.
Use the project cash flows for the following two mutually exclusive projects (A ; B):
Time
0
1
2
3
4
5
6
7
Project A
(725)
100
250
250
200
100
100
100
Project B
(850)
100
200
200
200
200
200
200
1Calculate NPV(A) and NPV (B) at a discount rate of 5%. Which project
should be selected?
2Calculate NPV(A) and NPV (B) at a discount rate of 10%. Which project
should be selected?
3Compute the two projects’ IRRs..
4Graph the NPV profiles for both projects on a common chart, making sure
that you identify all of the “crucial” points.
5Over what range of discount rates would you choose Project B? Project
A? And At what discount rate would you be indifferent between these two
Projects (crossover rate)?
Exercise 5
Project A has a NPV of $100 and an expected life of 3 years
Project B has a NPV of $130 and an expected life of 5 years
If your required rate of return is 12%, which project should you choose?
2
Exercise 6: Which of the following statements are true? (Only one answer is correct).
1. The present value of a project’s expected cash inflows is $3 million. If the project
requires an initial outlay of $2.5 million, its Profitability Index is:
A.
3.0
B.
2.5
C.
0.83
D.
1.2
E.
0.2
2. What is the decision rule for the internal rate of return (IRR)?
A.
accept a project when the IRR  r, where r is a rate set by management
B.
accept a project when the IRR  0
C.
accept a project when the IRR  100%, indicating that the project has
more than recaptured its initial cost
D.
accept a project when the IRR > NPV
E.
none of these is the correct rule
3. Which of the following is irrelevant to project evaluation?
A.
initial outlay
B.
terminal cash flows
C.
sunk costs
D.
differential cash flows over the project’s life
E.
cost of capital.
4. Which of the following measures is most suitable for choosing mutually exclusive
projects of unequal lives?
A.
Net Present Value
B.
Internal Rate of Return
C.
Accounting Rate of Return
D.
Equivalent Annual Annuity
E.
Profitability Index.
5. A major disadvantage of the payback period is that it
a.
b.
c.
d.
e.
Is useless as a risk indicator.
Ignores cash flows beyond the payback period.
Does not directly account for the time value of money.
Statements b and c are correct.
All of the statements above are correct.
3
Exercise7:
Suppose you are given the following data:
Sales
Variable Costs
Fixed Costs
Depreciation
Interest Expense
45,750,000
22,800,000
9,200,000
800,000
1,350,000
Taxe rate = 30%.
1- Calculate EBDIT.
2- Calculate EBIT.
3- Calculate net income.
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