FIN370 MyFinanceLab Week-3 NEW – 2015

1.) (Net present value calculation) Big Steve’s makers of
swizzle sticks, is considering the purchase of a new plastic stamping machine.
This investment requires an initial outlay of $95, 000 and will generate net
cash inflows of $17,000 per year for 8 years.

a. What is the project’s NPV using a discount rate of 9 percent? Should the
project be accepted? Why or Why not?
b. What is the project’s NPV using a discount rate of 17 percent? Should the
project be accepted? Why or Why not?
c. What is this project’s internal rate of return? Should the project be
accepted? Why or Why not?

2.) (IRR calculation) What is the internal rate of return
for the following project: An initial outlay of $9,500 resulting in a single
cash inflow of $29,942 in 11 years?

3.) (NPV and IRR calculation) East Coast Television is considering a project
with an initial outlay of $X (you will have to determine this amount). It is
expected that the project will produce a positive cash flow of $44,000 a year
at the end of each year for the next 13 years. The appropriate discount rate
for this project is 7 percent. If the project has an internal rate of return of
9 percent, what is the project’s net present value?

4.) (IRR and NPV calculation) The cash flows for three independent projects are
found below.
PROJECT A PROJECT B PROJECT C

YEAR 0 (INITIAL INVESTMENT) $(60,000) $(105,000) $(420,000)
Year 1 $11,000 $29,000 $220,000
YEAR 2 17,000 $29,000 $220,000
YEAR 3 21,000 29,000 $220,000
YEAR 4 28,000 29,000 ________
Year 5 32,000 29,000 _________

a. Calculate the IRR for each of the projects
b. If the discount rate for all three projects is 15 percent, which projects or
projects would you want to undertake?
c. What is the net present value of each of the projects where the appropriate
rate is 15 percent?

5. (IRR of an uneven cash flow stream) Microwave Oven Programming, Inc. is
considering the construction of a new plant. The plant will have an initial
cash outlay of $6.4 million (=-$6.4 million), and will produce a cash flow of
$2.7 million at the end of year 1, $4.2 million at the end of year 2, and $1.8
million at the end of years 3 through 5. What is the internal rate of return on
this new plant?

6. (NPV, PI, and IRR calculations) Fijisawa, Inc. is considering a major
expansion of its product line and has estimated the following cash flows
associated with such an expansion. The initial outlay would be $1,850,000 and
the project would generate cash flows of$520,000 per years. The appropriate
discount rate is 16.1 percent.
a. Calculate the net present value.
b. Calculate the profitability index
c. Calculate the internal rate of return.
d. Should this project be accepted? Why or why not?

7. (Payback period, net present value, profitability index, and internal rate
or return calculations) You are considering a project with an initial cash
outlay of $81,000 and expected cash flows of $25,110 at the end of each year
for six years. The discount rate for this project is 10.3 percent.
a. What are the project’s payback and discounted payback periods?
b. What is the project’s NPV?
c. What is the project’s PI?
d. What is the project’s IRR?

8. (Calculating operation cash flows) Assume that a new project will annually
generate revenues of $1,800,000 and cash expenses (including both fixed and
variable costs) of $700,000, while increasing depreciation by $190,000 per
year. In addition, the firm’s tax rate is 29 percent. Calculate the operating
cash flows for the new project.

9. (Calculating project cash flows and NPV) You are considering expanding your
product line that currently consists of skateboards to include gas powered
skateboards, and you feel expanding your product line that currently consists
of skateboards to include gas powered skateboards, and you feel you can sell 11,000
of these per year for 10 years (after which time this project is expected to
shut down with solar-powered skateboards taking over). The gas skateboards
would sell for $90 each with variable of costs of $50 for each one produced,
and annual fixed costs associated with production would be $190,000…….
a. What is the initial cash outlay associated with this project?
b. What are the annual net cash flows associated with this project for years 1
through 9?
c. What is the terminal cash flow in year 10 (that is, what is the free cash
flow in year 10 plus any additional cash flows associated with termination of
the project)?
d. What is the project’s NPV given a required rate of return of 7 percent?

10. (Inflation and project cash flows) Carlyle Chemicals is evaluating a new
chemical compound used in the manufacture of a wide range of consumer products.
The firm is concerned that inflation in the cost of raw materials will have an
adverse effect on the project’s flows. Specifically, the firm expects the cost
per unit (which is currently $0.87) will rise at a rate of 11 percent annually
over the next three years. The per-unit selling price is currently $1.01 and
this price is expected to rise at a merger 1 percent annual rate over the next
three years. If Carlyle expects to sell 6, 7.5, and 10 million units for the
next three years, respectively, what is your estimate of the gross profits to
the firm? Based on these estimates, what recommendation would you offer to the
firm’s management with regard to this product? (Note: Be sure to round each
unit price and unit cost per year to the nearest cent.)

11. (Calculating the expected NPV of a project) Management at the Doctors Bone
and Joint Clinic is considering whether to purchase a newly developed MRI
machine which they feel will provide the basis for better diagnoses of foot and
knee problems. The new machine is quite expensive and will be used for a number
of years. The clinic’s CFO asked an analyst to work up estimates of the NPV of
the investment under three different assumptions about the level of demand for
its use (high, medium, and low). The CFO assigned a 50 percent probability to
the medium-demand state, a 30 percent probability to the high state, and the
remaining 20 percent to the low state. After making forecasts of the demand for
the machine based on the CFO’s judgment and past utilization rates for MRI
scans, the following NPV estimates were made:
Demand State Probability of State NPV Estimate
Low 20% $(300,000)
Medium 50% $200,000
High 30% $400,000

a. What is the expected NPV for the MRI machine based on the above estimates?
How would you interpret the meaning of the expected NPV? Does this look like a
good investment to you?
b. Assuming that the probability of the medium-demand state remains 50 percent,
calculate the maximum probability you can assign to the low-demand state and
still have an expected NPV of 0 or higher.

12. (Scenario analysis) Family Security is considering introducing tiny GPS
trackers that can be inserted in the sole of a child’s shoe which would then
allow for the tracking of that child if he or she was ever lost or abducted.
The estimates, that might be off by 10 percent (either above or below),
associated with this new product are shown here:
Data Table
Unit price: $125
Variable costs: $75
Fixed costs: $250,000 per year
Expected sales: 10,000 pr year
Since this is a new
product line, you are not confident in your estimates and would like to know
how well you will fare if your estimates on the items listed above are 10 percent
lower than expected. Assume that this new product line will require an initial
outlay of $1.00 million, with no working capital investment, and will last for
10 years, being depreciated down to zero using straight-line depreciation. In
addition, the firm’s required rate to return or cost of capital is 10.0
percent, and the firm’s marginal tax rate is 34 percent. Calculate the
project’s NPV under the “best-case scenario” Calculate the project’s NPV under
the “worst-case scenario.”

13. (Real options and capital budgeting) You are considering introducing a new
Tex-Mex-Thai fusion restaurant. Upon closer examination, you find that there is
a 50 percent chance that this new restaurant will be well received and will
produce annual cash flows of $805, 000 per year forever (a perpetuity), while
there is a 50 percent chance of it producing a cash flow of only $191,000 per
year forever, (a perpetuity) if it isn’t well.
What is the expected NPV for this project if only one restaurant is built but
isn’t well received? What is expected NPV for this project assuming 15 more are
built if the first restaurant is well received?

14. (Identifying spontaneous, temporary, and permanent sources of financing)
Classify each of the following sources of new financing as a spontaneous,
temporary, or permanent:

a. A manufacturing firm enters into a loan agreement with its bank that calls
for annual principal and interest’s payments spread over the next four years.
b. A retail firm orders new items of inventory that are charged to the firm’s
trade credit.
c. A trucking firm issues common stock to the public and used the proceeds to
upgrade its tractor fleet.

15. (Evaluating trade credit discounts) IF a firm buys on
trade credit terms of 5/10, net 50 and decides to forgo the trade credit
discount and pay on the net day, what is the annualized costs of forgoing the
discount (assume a 360-day year)?