Question 1

Project Ell requires an initial investment of $50,000 and the produces annual cash flows of $30,000,$25,000,and $15,000.Project Ess requires an initial investment of $60,000 and then produces annual cash flows of $25,000 per year for the next ten years.The company ranks projects by their payback periods.

Accepted Answer

The payback method ranks projects based on the time it takes for the initial investment to be paid back. Ell has a payback period of 2.5 years ($50,000 initial investment / $30,000 annual cash flow in year 1 and 2), while Ess has a payback period of 2.4 years ($60,000 initial investment / $25,000 annual cash flow). Therefore, Ell will be ranked higher than Ess. It is important to note that the payback method does not take into account the time value of money or the total profitability of a project.

Question 2

MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000.The project will generate after-tax cash flows of $33,100 in Year 1,$31,500 in Year 2,and $31,200 in Year 3.Assume that the appropriate discount rate is 10% and that the firm's tax rate is 40%.What is the project's discounted payback period?

Accepted Answer

The discounted payback period is calculated by discounting the future cash flows back to their present value and then determining how long it takes for these discounted cash flows to pay back the initial investment. Here's the calculation:1. Discount the cash flows at the 10% discount rate:   - Year 1: $33,100 / (1 + 0.10)^1 = $30,090.91   - Year 2: $31,500 / (1 + 0.10)^2 = $26,033.06   - Year 3: $31,200 / (1 + 0.10)^3 = $23,283.192. Calculate the cumulative discounted cash flows:   - End of Year 1: $30,090.91   - End of Year 2: $30,090.91 + $26,033.06 = $56,123.97   - End of Year 3: $56,123.97 + $23,283.19 = $79,407.163. Determine the payback period:   - The initial investment of $75,000 is recovered between Year 2 and Year 3. To find the exact time, we see that at the end of Year 2, we have recovered $56,123.97. We need to recover the remaining $18,876.03 ($75,000 - $56,123.97) in Year 3. The discounted cash flow in Year 3 is $23,283.19, so we calculate the fraction of the year needed to recover the remaining amount: $18,876.03 / $23,283.19 ≈ 0.81 years.Adding this to the 2 years, the discounted payback period is approximately 2.81 years.

Question 3

Project H requires an initial investment of $100,000 and produces annual cash flows of $50,000,$40,000,and $30,000.Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000,$40,000,and $50,000.The projects are mutually exclusive.The company accepts projects with payback periods of 3 years or less.

Accepted Answer

To determine the payback period for each project, we add up the cash flows until we reach the initial investment:
- Project H: 
Year 1: $50,000 
Year 2: $90,000 ($50,000 + $40,000) 
Year 3: $120,000 ($50,000 + $40,000 + $30,000) 
Payback period: 3 years

- Project T: 
Year 1: $30,000 
Year 2: $70,000 ($30,000 + $40,000) 
Year 3: $120,000 ($30,000 + $40,000 + $50,000) 
Payback period: 3 years

Both projects meet the company's payback period criteria, but since they are mutually exclusive, only one can be accepted. Project H has higher cash flows in the earlier years, which may be more desirable for the company. Therefore, Project H is the best choice.

Question 4

Frazier Fudge has a project with an initial outlay of $40,000,followed by three years of annual incremental cash flows of $35,000.At the end of the third year,equipment will be sold producing additional cash flow of $10,000.Assuming a discount rate of 10%,which of the following is the correct equation to solve for the IRR of the project?

Accepted Answer

The IRR is found by setting the net present value (NPV) of cash flows to zero. The correct equation discounts each cash flow by (1 + IRR) raised to the power of the year it occurs.

Question 5

Use the following information to answer the following question.
Below are the expected after-tax cash flows for Projects Y and Z.Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
Project Y Project Z
Year 1 $12,000 $10,000
Year 2 $8,000 $10,000
Year 3 $6,000 0
Year 4 $2,000 0
Year 5 $2,000 0
-What is payback for Project Z?

Accepted Answer

To calculate payback, we need to accumulate the cash inflows until they equal the initial investment of $20,000. For Project Z, this is achieved in year 2 when the accumulated cash inflows equal $20,000 (year 1 cash inflow + year 2 cash inflow). Therefore, the payback for Project Z is two years. 
As for the best choice(s), it is difficult to determine without additional information. One possible method for evaluating the projects would be to calculate the net present value (NPV) of each project and choose the project with the highest NPV.

Question 6

Use the following information to answer the following question.
Below are the expected after-tax cash flows for Projects Y and Z.Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
Project Y Project Z
Year 1 $12,000 $10,000
Year 2 $8,000 $10,000
Year 3 $6,000 0
Year 4 $2,000 0
Year 5 $2,000 0
-Payback for Project Y is

Accepted Answer

The answer of Use the following information to answer the...

Question 7

MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000.The project will generate after-tax cash flows of $33,100 in Year 1,$31,500 in Year 2,and $31,200 in Year 3.Assume that the firm's proper rate of discount is 10% and that the firm's tax rate is 40%.What is the project's payback?

Accepted Answer

The payback period is the time it takes for the project to recover its initial investment from its cash inflows. Here, the cumulative cash flow at the end of Year 1 is $33,100, at the end of Year 2 is $64,600 ($33,100 + $31,500), and at the end of Year 3 is $95,800 ($64,600 + $31,200). The initial investment of $75,000 is recovered between Year 2 and Year 3. To find the exact payback period: at the end of Year 2, $64,600 has been recovered, leaving $10,400 ($75,000 - $64,600) to be recovered in Year 3. The cash flow in Year 3 is $31,200, so the fraction of the year needed to recover the remaining $10,400 is $10,400 / $31,200 = 0.33 years. Therefore, the total payback period is 2 years + 0.33 years = 2.33 years.

Question 8

A new forklift under consideration by Home Warehouse requires an initial investment of $100,000 and produces annual cash flows of $50,000,$40,000,and $30,000.Which of the following will not change if the required rate of return is increased from 10% to 12%.

Accepted Answer

The internal rate of return (IRR) will not change because it is based solely on the cash inflows and outflows of the investment and not on the required rate of return. However, the net present value (NPV), profitability index (PI), and modified internal rate of return (MIRR) will all change as these are affected by changes in the required rate of return.

Question 9

Project Black Swan requires an initial investment of $115,000.It has positive cash flows of $140,000 for each of the next two years.Because of major demolition and environmental clean-up costs,cash flow for the third and final year of the project is $(170,000).The company accepts all projects with a payback period of 2 years or less.

Accepted Answer

The answer of Project Black Swan requires an initial investment...

Question 10

WKW,Inc.is analyzing a project that requires an initial investment of $10,000,followed by cash inflows of $1,000 in Year 1,$4,000 in Year 2,and $15,000 in Year 3.The cost of capital is 10%.What is the profitability index of the project?

Accepted Answer

To calculate the profitability index, we divide the present value of the cash inflows by the initial investment.

PV of Year 1 cash inflow = $1,000 / (1 + 0.1) = $909.09
PV of Year 2 cash inflow = $4,000 / (1 + 0.1)^2 = $3,305.79
PV of Year 3 cash inflow = $15,000 / (1 + 0.1)^3 = $11,396.02

Total PV of cash inflows = $909.09 + $3,305.79 + $11,396.02 = $15,610.90

Profitability index = Total PV of cash inflows / Initial investment
= $15,610.90 / $10,000
= 1.56

Therefore, the profitability index of the project is 1.56, which means that for every dollar invested, the project is expected to return $1.56. The best choice would be B, as it has the highest profitability index.

Question 11

The owner of a small construction business has asked you to evaluate the purchase of a new front end loader.You have determined that this investment has a large,positive,NPV,but are afraid that your client will not understand the method.A good alternative method in this circumstance might be

Accepted Answer

The payback method is a simpler method of evaluating the profitability of an investment, as it measures the time it takes for the initial investment to be recovered. This may be a better option for the owner of a small construction business who may not have a strong background in finance and accounting. However, it should be noted that the payback method does not take into account the time value of money or the full net present value of the investment.

Question 12

The director of capital budgeting of South Park Development Corporation is evaluating a project that will cost $200,000;it is expected to last for 10 years and produce after-tax cash flows,including depreciation,of $44,503 per year.If the firm's cost of capital is 14% and its tax rate is 40%,what is the project's IRR?

Accepted Answer

To calculate the Internal Rate of Return (IRR) of the project, we need to find the discount rate that makes the present value of the cash inflows equal to the initial investment of $200,000.

Using a financial calculator or Excel, we find that the IRR of the project is 18.16%. Since this is higher than the cost of capital of 14%, the project is acceptable and will add value to the firm.

Therefore, the best choice is C) 18%.

Question 13

Use the following information to answer the following question.
Below are the expected after-tax cash flows for Projects Y and Z.Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
Project Y Project Z
Year 1 $12,000 $10,000
Year 2 $8,000 $10,000
Year 3 $6,000 0
Year 4 $2,000 0
Year 5 $2,000 0
-Discounted payback periods for projects Y and Z are

Accepted Answer

To find the discounted payback period, we need to calculate the present value of each cash flow using the required rate of return of 17%, and then add up the values until we reach the initial investment of $20,000.

For Project Y, the discounted cash flows are:

Year 1: $12,000 / (1.17)^1 = $10,256.41
Year 2: $8,000 / (1.17)^2 = $6,401.53
Year 3: $6,000 / (1.17)^3 = $4,464.76
Year 4: $2,000 / (1.17)^4 = $1,483.47
Year 5: $2,000 / (1.17)^5 = $1,160.10

Total present value: $23,766.27

Since it takes less than 3 years to reach the initial investment, the discounted payback period for Project Y is 2.68 years.

For Project Z, the discounted cash flows are:

Year 1: $10,000 / (1.17)^1 = $8,547.01
Year 2: $10,000 / (1.17)^2 = $6,803.07

Total present value: $15,350.08

Since it takes more than 3 years to reach the initial investment, the discounted payback period for Project Z is never.

Therefore, Project Y has a discounted payback period of 2.68 years, while Project Z's discounted payback period is never. Based on this analysis, Project Y is the better choice.

Question 14

You are considering investing in a project with the following year-end after-tax cash flows:
Year 1: $5,000
Year 2: $3,200
Year 3: $7,800
If the initial outlay for the project is $12,113,compute the project's IRR.

Accepted Answer

The answer of You are considering investing in a project...

Question 15

Frazier Fudge has a project with an initial outlay of $40,000,followed by three years of annual incremental cash flows of $35,000.At the end of the third year,equipment will be sold producing additional cash flow of $10,000.Assuming a cost of capital of 10%,calculate the MIRR of the project.

Accepted Answer

MIRR is the rate that equates the present value of the inflows to the present value of the outflows. In this case, the present value of the inflows is $100,000 and the present value of the outflows is $40,000. Therefore, the MIRR is 10%.

Question 16

Consider a project with the following cash flows:
After-Tax After-Tax
Accounting Cash Flow
Year Profits from Operations
1 $799 $750
2 $150 $1,000
3 $200 $1,200
Initial outlay = $1,500
Terminal cash flow = 0
Compute the profitability index if the company's discount rate is 10%.

Accepted Answer

To calculate the profitability index, we first need to calculate the present value of each cash flow:
PV of Year 1 cash flow = $750 / (1 + 0.1)1 = $681.82
PV of Year 2 cash flow = $1,000 / (1 + 0.1)2 = $826.45
PV of Year 3 cash flow = $1,200 / (1 + 0.1)3 = $973.79

Next, we add up the present values of all the cash flows (including the initial outlay):
PV of all cash flows = $681.82 + $826.45 + $973.79 - $1,500 = $981.06

Finally, we divide the PV of all cash flows by the initial outlay to get the profitability index:
Profitability Index = $981.06 / $1,500 = 1.61

A profitability index greater than 1 indicates that the project is expected to generate positive value, so the best choice is to proceed with the project.

Question 17

Which of the following series of cash flows could have more than one IRR? (Negative cash flows are in parentheses. )

Accepted Answer

A series of cash flows can have more than one IRR when there is a sign change in the cash flows, meaning there is at least one negative cash flow followed by a positive cash flow, or vice versa. In option B, there is a sign change in the cash flows with the negative cash flow being $(XX,XXX)$ followed by positive cash flows, which means there could be more than one IRR. The other options do not have a sign change in the cash flows, so there can only be a single IRR.

Question 18

Analysis of a machine indicates that it has a cost of $5,375,000.The machine is expected to produce cash inflows of $1,825,000 in Year 1;$1,775,000 in Year 2;$1,630,000 in Year 3;$1,585,000 in Year 4;and $1,650,000 in Year 5.What is the machine's IRR?

Accepted Answer

To calculate IRR, we need to find the discount rate at which the present value of the cash inflows equals the cost of the machine. Using a financial calculator or Excel, we can find that the IRR for this machine's cash flows is approximately 17.81%. This means that the machine's cash inflows are expected to yield a return of 17.81%, which is greater than the cost of the machine. Therefore, the best choice would be to invest in this machine.

Question 19

The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in Years 1 through 4,$35,000 per year in Years 5 through 9,and $40,000 in Year 10.This investment will cost the firm $100,000 today,and the firm's cost of capital is 10%.Assume cash flows occur evenly during the year.

Accepted Answer

The payback period is calculated by determining how long it takes for the cumulative cash flows to equal the initial investment. At a 10% cost of capital, the discounted cash flows need to be calculated for each year and summed until they equal or exceed $100,000. The correct payback period is approximately 4.26 years.

Question 20

Manheim Candles is considering a project with the following incremental cash flows.Assume a discount rate of 10%.
Year Cash Flow
0 ($20,000)
1 0
2 $30,000
3 $30,000
Calculate the project's MIRR.(Round to the nearest whole percentage. )

Accepted Answer

First, we need to calculate the present value of the cash flows from year 2 and 3, which is $52,853 [(30,000/1.1^2) + (30,000/1.1^3)]. 
Then, we need to find the discount rate that gives us an NPV of 0 for the entire cash flow stream using the formula: 
NPV = CF0 + (CF1/(1+r)^1) + (CF2/(1+r)^2) + (CF3/(1+r)^3) = 0 
Solving for r, we get a discount rate of 15.03%. 
Next, we use the formula for MIRR: 
MIRR = [(FV of positive cash flows / PV of negative cash flows)^(1/n) -1] * (1+i) 
The FV of positive cash flows is $52,853 and the PV of negative cash flows is $20,000. So, 
MIRR = [(52,853/20,000)^(1/3) -1] * (1+15.03%) = 47% 
Therefore, the project's MIRR is 47%. This exceeds the discount rate of 10% and is a positive measure of the project's profitability. Therefore, the project should be accepted.

Quiz 11: Investment Decision Criteria

A new forklift under consideration by Home Warehouse requires an initial investment of $100,000 and produces annual cash flows of $50,000,$40,000,and $30,000.Which of the following will not change if the required rate of return is increased from 10% to 12%.

WKW,Inc.is analyzing a project that requires an initial investment of $10,000,followed by cash inflows of $1,000 in Year 1,$4,000 in Year 2,and $15,000 in Year 3.The cost of capital is 10%.What is the profitability index of the project?

The owner of a small construction business has asked you to evaluate the purchase of a new front end loader.You have determined that this investment has a large,positive,NPV,but are afraid that your client will not understand the method.A good alternative method in this circumstance might be

You are considering investing in a project with the following year-end after-tax cash flows: Year 1: $5,000 Year 2: $3,200 Year 3: $7,800 If the initial outlay for the project is $12,113,compute the project's IRR.

Frazier Fudge has a project with an initial outlay of $40,000,followed by three years of annual incremental cash flows of $35,000.At the end of the third year,equipment will be sold producing additional cash flow of $10,000.Assuming a cost of capital of 10%,calculate the MIRR of the project.

Consider a project with the following cash flows: After-Tax After-Tax Accounting Cash Flow Year Profits from Operations 1 $799 $750 2 $150 $1,000 3 $200 $1,200 Initial outlay = $1,500 Terminal cash flow = 0 Compute the profitability index if the company's discount rate is 10%.

Which of the following series of cash flows could have more than one IRR? (Negative cash flows are in parentheses. )

Analysis of a machine indicates that it has a cost of $5,375,000.The machine is expected to produce cash inflows of $1,825,000 in Year 1;$1,775,000 in Year 2;$1,630,000 in Year 3;$1,585,000 in Year 4;and $1,650,000 in Year 5.What is the machine's IRR?

Manheim Candles is considering a project with the following incremental cash flows.Assume a discount rate of 10%. Year Cash Flow 0 ($20,000) 1 0 2 $30,000 3 $30,000 Calculate the project's MIRR.(Round to the nearest whole percentage. )