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13. Aerospace Dynamics will invest $1
10,000
in a project that will produce the following cash flows. The cost of capital is 11 percent. Should the project be undertaken? (Note that the fourth year’s cash flow is negative.)
|
Year |
Cash Flow |
||||||||||||||||||
|
1……………. |
$ | 3 |
6,000 |
||||||||||||||||
|
2……………. |
44,000 |
||||||||||||||||||
|
3……………. |
3 |
8,000 |
|||||||||||||||||
|
4……………. |
(44,000) |
||||||||||||||||||
|
5……………. |
81,000 |
14. The Horizon Company will invest $60,000 in a temporary project that will generate the following cash inflows for the next three years.
| $1 |
5,000 |
||
|
25,000 |
|||
|
40,000 |
The firm will also be required to spend
$10,000
to close down the project at the end of the three years. If the cost of capital is 10 percent, should the investment be undertaken?
15. Skyline Corp. will invest $1
30,000
in a project that will not begin to produce returns until after the 3rd year. From the end of the 3rd year until the end of the 12th year (10 periods), the annual cash flow will be $34,000. If the cost of capital is 12 percent, should this project be undertaken?
16. The Ogden Corporation makes an investment of $25,000, which yields the following cash flows:
|
$ 5,000 |
|||
|
9,000 |
|||
a. What is the present value with a 9 percent discount rate (cost of capital)?
b. What is the internal rate of return?
Use the interpolation procedure shown in this chapter.
c. In this problem would you make the same decision in parts a and b
17. The Danforth Tire Company is considering the purchase of a new machine that would increase the speed of manufacturing and save money. The net cost of this machine is $66,000. The annual cash flows have the following projections.
|
$21,000 |
|
|
29,000 |
|
|
16,000 |
|
a. If the cost of capital is 10 percent, what is the net present value?
b. What is the internal rate of return?
c. Should the project be accepted? Why?
18. You are asked to evaluate two projects for Adventures Club, Inc. Using the net present value method combined with the profitability index approach described in footnote 2 on page ____, which project would you select? Use a discount rate of 12 percent.
|
Project |
Project Y (international film festivals) ($22,000 investment) |
|||
|
1………………………… |
$4,000 |
1…………………………… |
$10,800 |
|
|
2………………………… |
2…………………………… |
9,600 |
||
|
3………………………… |
4,200 |
3…………………………… |
||
|
4………………………… |
3,600 |
4…………………………… |
7,000 |
19. Cablevision, Inc., will invest $48,000 in a project. The firm’s discount rate (cost of capital) is 9 percent. The investment will provide the following inflows.
|
19,000 |
|
|
20,000 |
The internal rate of return is 15 percent.
a. If the reinvestment assumption of the net present value method is used, what will be the total value of the inflows after five years? (Assume the inflows come at the end of each year.)
b. If the reinvestment assumption of the internal rate of return method is used, what will be the total value of the inflows after five years?
c. Generally is one investment assumption likely to be better than another?
20. The 21st Century Corporation uses the modified internal rate of return. The firm has a cost of capital of 8 percent. The project being analyzed is as follows (
$20,000
investment):
|
6,800 |
a. What is the modified internal rate of return? An approximation from Appendix B is adequate. (You do not need to interpolate.)
b. Assume the traditional internal rate of return on the investment is 14.9 percent. Explain why your answer in part a would be lower.
21. Oliver Stone and Rock Company uses a process of capital rationing in its decision making. The firm’s cost of capital is 12 percent. It will invest only $80,000 this year. It has determined the internal rate of return for each of the following projects.
|
Project Size |
Percent of Internal Rate of Return |
||
|
A……………………. |
$ |
15,000 |
14% |
|
B…………………….. |
|||
|
C…………………….. |
|||
|
D……………………. |
16.5 |
||
|
E…………………….. |
|||
|
F…………………….. |
|||
|
G……………………. |
|||
|
H……………………. |
17.5 |
a. Pick out the projects that the firm should accept.
b. If Projects B and G are mutually exclusive, how would that affect your overall answer? That is, which projects would you accept in spending the $80,000?
22. Miller Electronics is considering two new investments. Project C calls for the purchase of a coolant recovery system. Project H represents an investment in a heat recovery system. The firm wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows:
|
Project C ($25,000 Investment) |
Project H ($25,000 investment) |
|
|
1…………………….. |
$ 6,000 |
1…………………………. |
|
2…………………….. |
2…………………………. |
|
|
3…………………….. |
3…………………………. |
|
|
4…………………….. |
13,000 |
a. Determine the net present value of the projects based on a zero discount rate.
b. Determine the net present value of the projects based on a 9 percent discount rate.
c. The internal rate of return on Project C is 13.01 percent, and the internal rate of return on Project H is 15.68 percent. Graph a net present value profile for the two investments similar to Figure 12-3. (Use a scale up to $10,000 on the vertical axis, with $2,000 increments. Use a scale up to 20 percent on the horizontal axis, with 5 percent increments.)
d. If the two projects are not mutually exclusive, what would your acceptance or rejection decision be if the cost of capital (discount rate) is 8 percent? (Use the net present value profile for your decision; no actual numbers are necessary.)
e. If the two projects are mutually exclusive (the selection of one precludes the selection of the other), what would be your decision if the cost of capital is (1) 5 percent, (2) 13 percent, (3) 19 percent? Use the net present value profile for your answer.
23. Software Systems is considering an investment of $20,000, which produces the following inflows:
|
$11,000 |
|
5,800 |
You are going to use the net present value profile to approximate the value for the internal rate of return. Please follow these steps:
a. Determine the net present value of the project based on a zero discount rate.
b. Determine the net present value of the project based on a 10 percent discount rate.
c. Determine the net present value of the project based on a 20 percent discount rate (it will be negative).
d. Draw a net present value profile for the investment. (Use a scale up to $6,000 on the vertical axis, with $2,000 increments. Use a scale up to 20 percent on the horizontal axis, with 5 percent increments.) Observe the discount rate at which the net present value is zero. This is an approximation of the internal rate of return on the project.
e. Actually compute the internal rate of return based on the interpolation procedure presented in this chapter. Compare your answers in parts d and e.
24. Howell Magnetics Corporation is going to purchase an asset for $400,000 that will produce $180,000 per year for the next four years in earnings before depreciation and taxes. The asset will be depreciated using the three-year MACRS depreciation schedule in Table 12-9. (This represents four years of depreciation based on the half-year convention.) The firm is in a 34 percent tax bracket. Fill in the schedule below for the next four years. (You need to first determine annual depreciation.)
|
Earnings before depreciation and taxes |
_____ |
||||||
|
Depreciation |
|||||||
|
Earnings before taxes |
|||||||
|
Taxes |
|||||||
|
Earnings after taxes |
|||||||
|
+ Depreciation |
|||||||
|
Cash flow |
25. Assume $80,000 is going to be invested in each of the following assets. Using Tables 12-8 and 12-9, indicate the dollar amount of the first year’s depreciation.
a. Computers
b. Petroleum refining product
c. Office furniture
d. Pipeline distribution
26. The Keystone Corporation will purchase an asset that qualifies for three-year MACRS depreciation. The cost is $60,000 and the asset will provide the following stream of earnings before depreciation and taxes for the next four years:
Year 1……………… $27,000
Year 2……………… 30,000
Year 3……………… 23,000
Year 4……………… 15,000
The firm is in a 36 percent tax bracket and has an 11 percent cost of capital. Should it purchase the asset?
27. Oregon Forest Products will acquire new equipment that falls under the five-year MACRS category. The cost is $300,000. If the equipment is purchased, the following earnings before depreciation and taxes will be generated for the next six years.
Year 1………………… $112,000
Year 2………………… 105,000
Year 3………………… 82,000
Year 4………………… 53,000
Year 5………………… 37,000
Year 6………………… 32,000
The firm is in a 30 percent tax bracket and has a 14 percent cost of capital. Should Oregon Forest Products purchase the equipment? Use the net present value method.
28. The Thorpe Corporation is considering the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation range (ADR). Carefully refer to Table 12-8 to determine in what depreciation category the asset falls. (Hint: It is not 10 years.) The asset will cost $80,000, and it will produce earnings before depreciation and taxes of $28,000 per year for three years, and then $12,000 a year for seven more years. The firm has a tax rate of 34 percent. With a cost of capital of 12 percent, should it purchase the asset? Use the net present value method. In doing your analysis, if you have years in which there is no depreciation, merely enter a zero for depreciation.
