1. A project has an initial cost of $54,000, expected net cash inflows of $15,000 per year for 11 years, and a cost of capital of 11%. What is the project’s NPV? (Hint: Begin by constructing a time line.) Do not round your intermediate calculations. Round your answer to the nearest cent.
$__________________
2. New-Project Analysis
The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is $890,000, and it would cost another $20,000 to install it. The machine falls into the MACRS 3-year class (the applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%), and it would be sold after 3 years for $605,000. The machine would require an increase in net working capital (inventory) of $16,500. The sprayer would not change revenues, but it is expected to save the firm $475,000 per year in before-tax operating costs, mainly labor. Campbell’s marginal tax rate is 30%.
a) What is the Year-0 net cash flow?
b) What are the net operating cash flows in Years 1, 2, 3? Round your answers to the near dollars.
_________ Year 1
_________ Year 2
_________ Year 3
c) What is the additional Year-3 cash flow (i.e, the after-tax salvage and the return of working capital)? Round your answer to the nearest dollar.
$__________
d) If the project’s cost of capital is 15%, what is the NPV of the project? Round your answer to the nearest dollar.
$_________
e) Should the machine be purchased?
____ Yes _____ No
?
3. Depreciation Methods
Wendy’s boss wants to use straight-line depreciation for the new expansion project because he said it will give higher net income in earlier years and give him a larger bonus. The project will last 4 years and requires $700,000 of equipment. The company could use either straight-line or the 3-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would be depreciated evenly over its 4-year life (ignore the half-year convention for the straight-line method). The applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%. The company’s WACC is 8%, and its tax rate is 35%.
1. What would the depreciation expense be each year under each method?
Year Straight Line MACRS
1 __________ _______
2 __________ _______
3 __________ _______
4 __________ _______
2. Which depreciation method would produce the higher NPV?
Straight Line_____________ MACRS____________
3. How much higher would it be? Round your answer to the nearest dollar.
$_______________________
4. NPV and IRR Analysis
After discovering a bew gold vein in Colorado Mountains, CTC Mining Corporation must decide whether to go ahead and develop the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process that results in environmental damage. Before proceeding with the extraction, CTC must spend $900,000 for new mining equipment and pay $165,000 for its installation. The gold mined will net the firm an estimated $350,000 each year over the 5-year life of the vein. CTC’s cost of capital is 13%. For the purposes of this problem, assume that the cash inflows occur at the end of the year.
1 What is the project’s NPV? Round your answer to the nearest dollar
$___________________
What is the project’s IRR? Round your answer to two decimal places.
___________________%
2. Should this project be undertaken if environment impacts were not consideration?
_______ Yes _________No
3. How should environmental effects be considered when evaluating this, or any other, project? (Circle one) . I. Environmental effects should be treated as sunk costs.
II. Environmental effects could be added by estimating penalties or any other cash outflows .
that might be imposed on the firm to help return the land to its previous state (if possible).
III. Environmental effects should be ignored since they would have no effect on the project’s
profitability.
5. Timing Differences
The Ewert Exploration Company is considering two mutually exclusive plans for extracting oil on property for which it has mineral rights. Both plans call for the expenditure of $9.5 million to drill development wells. Under Plan A, all the oil will be extracted in 1 year, producing a cash flow at t = 1 of $10.5 million; under Plan B, cash flows will be $1.4 million per year for 20 years.
1. What are the annual incremental cash flows that will be available to Ewert Exploration if it undertakes Plan B rather than Plan A? (Hint: Subtract Plan A’s flows from B’s.)
Year Incremental Cash Flow (B-A)
1 $_________________
2-20 $_________________
If the company accepts Plan A and then invests the extra cash generated at the end of Year 1, what rate of return (reinvestment rate) would cause the cash flows from reinvestment to equal the cash flows from Plan B? Round your answer to two decimal places.
_________________%
2. Suppose a firm’s cost of capital is 10%. Is it logical to assume that the firm would take on all available independent projects (of average risk) with returns greater than 10%? Further, if all available projects with returns greater than 10% have been taken, would this mean that cash flows from past investments would have an opportunity cost of only 10%, because all the firm could do with these cash flows would be to replace money that has a cost of 10%? Finally, does this imply that the cost of capital is the correct rate to assume for the reinvestment of a project’s cash flows? Answer below:
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
3. Construct NPV profiles for Plans A and B.
Select the correct Graph.
Which graph is correct? ____A ____B ____ C _____D
Identify each project’s IRR. Round your answers to two decimal places.
Project A ____________________%
Project B ____________________%
What is the crossover rate? Round your answer to two decimal places.
_______________%
6. Scale Differences
The Pinkerton Publishing Company is considering two mutually exclusive expansion plans. Plan A calls for the expenditure of $50 million on a large-scale, integrated plant that will provide an expected cash flow stream of $8 million per year for 20 years. Plan B calls for the expenditure of $15 million to build a somewhat less efficient, more labor-intensive plant that has an expected cash flow stream of $3.4 million per year for 20 years. The firm’s cost of capital is 10%.
a) Calculate each project’s NPV. Round your answers to the nearest dollar.
Project A ____________________%
Project B ____________________%
b) Calculate each project’s IRR. Round your answer to two decimal places.
Project A ____________________%
Project B ____________________%
c) Set up a Project ? by showing the cash flows that will exist if the firm goes with the large . plant rather than the smaller plant.
Year Project ? Cash Flows
0 $_______________
1-20 $_______________
d) What is the NPV for this Project ?? Round to the nearest dollar.
$___________________
e) What is the IRR for this Project ?? Round to the nearest two decimal places.
_______________%
f) Graph the NPV profiles for Plan A, Plan B, and Project ?
Select the correct graph.
7. Replacement Analysis
Although the Chen Company’s milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $41,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $9,400 per year. It would have zero salvage value at the end of its life. The firm’s WACC is 11%, and its marginal tax rate is 35%.
Should Chen buy the new machine?
______Yes _______No
8. Net Salvage Value
Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost $13 million, of which 80% has been depreciated. The used equipment can be sold today for $4.55 million, and its tax rate is 40%. What is the equipment’s after-tax net salvage value? Write out your answer completely. For example, 2 million should be entered as 2,000,000.
$_______________
9. Operating Cash Flow
The financial staff of Cairn Communications has identified the following information for the first year of the roll-out of its new proposed service:
Projected sales $25 million
Operating costs (not including depreciation) 11 million
Depreciation 5 million
Interest expense 3 million
The company faces a 35% tax rate. What is the project’s operating cash flow for the first year (t = 1)? Write out your answer completely. For example, 2 million should be entered as 2,000,000.
$______________
10. NPVs and IRRs for Mutually Exclusive Projects
Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Since both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate; it will cost $21,500, whereas the gas-powered truck will cost $17,960. The cost of capital that applies to both investments is 13%. The life for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $6,860 per year and those for the gas-powered truck will be $4,600 per year. Annual net cash flows include depreciation expenses.
a) Calculate the NPV for each type of truck. Round to the nearest dollar.
Electric-powered truck $________________
Gas-powered truck $________________
b) Calculate the IRR for each type of truck. Round to the two decimal places.
Electric-powered truck ________________%
Gas-powered truck ________________%
c) Which type of the truck should the firm purchase?
Electric-powered truck ____________ Gas-powered truck__________
