[i]. Real
Time Systems Inc. is considering the development of one of two mutually
exclusive new computer models. Each will require a net investment of $5,000.
The cash flow figures for each project are shown below:
Period Project A Project B
1 $2,000 $3,000
2 2,500 2,600
3 2,250 2,900
Model B, which will use a new type of laser
disk drive, is considered a high-risk project, while Model A is of average
risk. Real Time adds 2 percentage points to arrive at a risk-adjusted cost of
capital when evalĀuating a high-risk project. The cost of capital used for
average-risk projects is 12 percent. Which of the following statements
regarding the NPVs for Models A and B is most correct?
a. NPV_{A}
= $380; NPV_{B} = $1,815.
b. NPV_{A}
= $197; NPV_{B} = $1,590.
c. NPV_{A}
= $380; NPV_{B} = $1,590.
d. NPV_{A}
= $5,380; NPV_{B} = $6,590.
e. None
of the statements above is correct.
[ii]. Cochran
Corporation has a weighted average cost of capital of 11 percent for projects
of average risk. Projects of
below-average risk have a cost of capital of 9 percent, while projects of
above-average risk have a cost of capital equal to 13 percent. Projects A and B are mutually exclusive,
whereas all other projects are independent.
None of the projects will be repeated.
The following table summarizes the cash flows, internal rate of return
(IRR), and risk of each of the projects.
Year (t) |
Project A |
Project B |
Project C |
Project D |
Project E |
0 |
-$200,000 |
-$100,000 |
-$100,000 |
-$100,000 |
-$100,000 |
1 |
66,000 |
30,000 |
30,000 |
30,000 |
40,000 |
2 |
66,000 |
30,000 |
30,000 |
30,000 |
25,000 |
3 |
66,000 |
40,000 |
30,000 |
40,000 |
30,000 |
4 |
66,000 |
40,000 |
40,000 |
50,000 |
35,000 |
IRR |
12.110% |
14.038% |
10.848% |
16.636% |
11.630% |
Project Risk |
Below Average |
Below Average |
Average |
Above Average |
Above Average |
Which projects will the firm select for
investment?
a. Projects: A, B, C, D, E
b. Projects: B, C, D, E
c. Projects: B, D
d. Projects: A, D
e. Projects: B, C, D
Multiple
part:
(The
following information applies to the next four problems.)
[MACRS table required]
The president of Real Time Inc. has asked
you to evaluate the proposed acquisition of a new computer. The computer’s price is $40,000, and it falls
into the MACRS 3-year class. Purchase of
the computer would require an increase in net operating working capital of
$2,000. The computer would increase the
firm’s before-tax revenues by $20,000 per year but would also increase
operating costs by $5,000 per year. The
computer is expected to be used for 3 years and then be sold for $25,000. The firm’s marginal tax rate is 40 percent,
and the project’s cost of capital is 14 percent.
[iii]. What
is the net investment required at t = 0?
a. -$42,000
b. -$40,000
c. -$38,600
d. -$37,600
e. -$36,600
[iv]. What
is the operating cash flow in Year 2?
a. $
9,000
b. $10,240
c. $11,687
d. $13,453
e. $16,200
[v]. What
is the total value of the terminal year non-operating cash flows at the end of
Year 3?
a. $18,120
b. $19,000
c. $21,000
d. $25,000
e. $27,000
[vi]. What
is the project’s NPV?
a. $2,622
b. $2,803
c. $2,917
d. $5,712
e. $6,438
.
.
.
.