Question 1

Project Q has an initial cost of $211,415 and projected cash flows of $121,300 in Year 1 and $176,300 in Year 2.Project R has an initial cost of $415,000 and projected cash flows of $187,500 in Year 1 and $236,600 in Year 2.The discount rate is 8.5 percent and the projects are independent.Which project(s),if either,should be accepted based on its profitability index value?

Accepted Answer

PI_Q = ($121,300/1.085 + $176,300/1.085²)/$211,415 = 1.24;AcceptPI_R = ($187,500/1.085 + $236,600/1.085²)/$415,000 = .90;Reject

Question 2

A proposed project has an initial cost of $475,000 and cash flows of -$21,200,$367,500,and $287,000 for Years 1 to 3,respectively.Victoria,the boss,insists that only projects that can return at least $1.10 in today's dollars for every $1 invested can be accepted.She also insists on applying a discount rate of 12 percent to all cash flows.Based on these criteria,the project should be:

Accepted Answer

The PI method should be used with a required value of 1.1.PI = (-$21,200/1.12 + $367,500/1.12² + $287,000/1.12³)/$475,000 = 1.01;Reject

Question 3

It will cost $3,200 to acquire a small ice cream cart.Cart sales are expected to be $1,500 a year for three years.After the three years,the cart is expected to be worthless.What is the payback period?

Accepted Answer

Payback period = 2 + [$3,200 - (2 × $1,500)]/$1,500 = 2.13 years

Question 4

Rodriquez's Hot Rods is considering a new project with an initial cost of $26,410 and a discount rate of 8 percent.The project is expected to have one cash inflow of $42,500 in Year 2.What is the discounted payback period?

Accepted Answer

Discounted Year 2 cash flow = $42,500/1.08² = $36,436.90Discounted payback period = 1 + $26,410/$36,436.90 = 1.72 years

Question 5

Toy Town is considering a new toy that will cost $49,100 in startup costs.The toy is expected to produce cash flows of $47,500 in Year 1 and $18,600 in Year 2.The toy will be discontinued after the second year.The discount rate assigned to the toy is 14.9 percent.Should the toy be produced? What is the IRR?

Accepted Answer

NPV = $0 = -$49,100 + $47,500/(1 + IRR)+ $18,600/(1 + IRR)²IRR = 26.65%

Question 6

Bloomfield Tires has assigned a discount rate of 14.4 percent to a new project that has an initial cost of $229,000 and cash flows of $74,300,$128,700,and $89,500 for Years 1 to 3,respectively.What is the net present value of this project?

Accepted Answer

NPV = -$229,000 + $74,300/1.144 + $128,700/1.144² + $89,500/1.144³ = -$5,934.79

Question 7

Baxter's Market is considering opening a new location with an initial cost of $428,700.This location is expected to generate cash flows of $132,400,$161,500,$187,800,and $201,000 in Years 1 to 4.What is the payback period?

Accepted Answer

Payback period = 2 + ($428,700 - 132,400 - 161,500)= 2.72 years

Question 8

A project has an initial cost of $68,300 and cash flows of $38,700,$102,300,and -$18,100 for Years 1 to 3,respectively.If the required rate of return for this investment is 8.7 percent,should you accept it based solely on the internal rate of return rule? Why or why not?

Accepted Answer

Since the cash flow in Year 3 is a negative value,there are multiple IRRs.Thus,the IRR rule does not apply.

Question 9

You are considering two independent projects both of which have been assigned a discount rate of 8 percent.Project A costs $13,100 and produces cash flows of $5,300 a year for three years.Project B costs $21,900 and produces cash flows of $12,000 a year for two years.Based on the profitability index,what is your recommendation concerning these projects?

Accepted Answer

PI_A = ($5,300/1.08 + $5,300/1.08² + $5,300/1.08³)= 1.04;AcceptPI_B = ($12,000/1.08 + $12,000/1.08²)/$21,900 = .98;Reject

Question 10

You are considering a project with an initial cost of $4,600.What is the payback period for this project if the cash inflows are $450,$970,$2,800,and $500 a year for Years 1 to 4,respectively?

Accepted Answer

Payback period = 3 + ($4,600 - 450 - 970 - 2,800)/$500 = 3.76 years

Question 11

Project Water has an initial cost of $639,700 and projected cash flows of $288,000,$319,000,and $165,000 for Years 1 to 3,respectively.Project Aqua has an initial cost of $411,200 and projected cash flows of $186,000,$178,000,and $145,000 for Years 1 to 3,respectively.What is the incremental IRR of these two mutually exclusive projects?

Accepted Answer

Incremental cash flows:Time 0: -$639,700 - (-$411,200)= -$228,500Year 1: $288,000 - 186,000 = $102,000Year 2: $319,000 - 178,000 = $141,000Year 3: $165,000 - 145,000 = $20,000Incremental IRR = -$228,500 + $102,000/(1 + IRR)+ $141,000/(1 + IRR)² + $20,000/(1 + IRR)³IRR = 8.77%

Question 12

What is the net present value of a project that has an initial cash outflow of $12,670 and cash inflows of $2,400 a year for Years 1 and 2 and a final cash inflow in Year 6 of $15,400? The required return is 14.5 percent.

Accepted Answer

NPV = -$12,670 + $2,400/1.145 + $2,400/1.145² + $15,400/1.145⁶ = -$1,909.10

Question 13

A new product has startup costs of $338,200 and projected cash flows of $102,000,$187,500,and $245,000 for Years 1 to 3,respectively.What is the profitability index given a 9 percent required return?

Accepted Answer

PI = ($102,000/1.09 + $187,500/1.09² + $245,000/1.09³)/$338,200 = 1.30

Question 14

A project has an initial cost of $38,300 and anticipated cash flows of $9,200,$18,700,$14,600 for Years 1 to 3,respectively.What is the profitability index value if the required return is 9.5 percent?

Accepted Answer

PI = ($9,200/1.095 + $18,700/1.095² + $14,600/1.095³)/$38,300 = .92

Question 15

A project will not produce any cash flows for two years.Starting in the third year,it will produce annual cash flows of $11,900 a year for two years.The project initially costs $43,600.In Year 6,the project will be closed and as a result should produce a final cash inflow of $50,500.What is the net present value of this project if the required rate of return is 8.7 percent?

Accepted Answer

NPV -$43,600 + $11,900/1.087³ + $11,900/1.087⁴ + $25,500/1.087⁶ = $4,802.57

Question 16

Miller's is considering a 2-year expansion project that will require $410,000 up front.The project will produce cash flows of $358,000 and $98,000 for Years 1 and 2,respectively.Based on the profitability index (PI)rule,should the project be accepted if the discount rate is 12 percent? Why or why not?

Accepted Answer

PI = ($358,000/1.12 + $98,000/1.12²)/$410,000 = .97

Question 17

A project costs $22,900 to initiate.It is expected to provide cash flows of $15,900 in Year 1 and $9,900 in Year 2.In Year 3,it will cost the firm $5,500 to end the project.What is the modified IRR at a discount rate of 14 percent?

Accepted Answer

Modified Year 2 cash flow = $9,900 + (-$5,500/1.14)= $5,075.44Modified IRR: $0 = -$22,900 + $15,900/(1 + IRR)+ $5,075.44/(1 + IRR)²Modified IRR = -6.79%

Question 18

What is the internal rate of return on an investment that has an initial cost of $38,400 and projected cash inflows of $11,200,$19,600,and $18,100 for Years 1 to 3,respectively?

Accepted Answer

NPV = $0 = -$38,400 + $11,200/(1 + IRR)+ $19,600/(1 + IRR)² + $18,100/(1 + IRR)³IRR = 12.15%

Question 19

Benji's has an opportunity with an initial cash flow of $48,900 and future cash flows of -$31,300 in Year 1 and -$21,600 in Year 2.The discount rate is 7 percent.Should this project be accepted or rejected? Why?

Accepted Answer

IRR = $48,900 + [-$31,300/(1 + IRR)] + [-$21,600/(1 + IRR)²]IRR = 5.77%NPV = $48,900 + (-$31,300/1.07)+ (-$21,600/1.07²)= $781.39Since this is a financing type project,the project should be accepted because the IRR is less than the discount rate.This is confirmed by the positive NPV computed using the discount rate.

Question 20

A project requires an initial investment of $21,600 and will produce cash inflows of $4,900,$14,200,and $8,700 over the next three years,respectively.What is the project's NPV at a required return of 14 percent?

Accepted Answer

NPV = -$21,600 + $4,900/1.14 + $14,200/1.14² + $8,700/1.14³ = -$503.06

Quiz 7: Net Present Value and Other Investment Rules