Question 1

A project produces annual net income of $9,500,$12,500,and $15,500 over its 3-year life.The initial cost of the project is $210,000.This cost is depreciated straightline to a zero book value over three years.What is the average accounting rate of return if the required discount rate is 12.25 percent?

Accepted Answer

Average net income = ($9,500 + 12,500 + 15,500)/3 = $12,500Average book value = ($210,000 + 140,000 + 70,000 + 0)/4 = $105,000AAR = $12,500/$105,000 = .1190,or 11.90%

Question 2

A project has an initial cost of $10,800 and produces cash inflows of $4,100,$4,800,and $5,600 over Years 1 to 3,respectively.What is the discounted payback period if the required rate of return is 11 percent?

Accepted Answer

Discounted cash flows:Year 1 = $4,100/1.11 = $3,693.69Year 2 = $4,800/1.11² = $3,895.79Year 3 = $5,600/1.11³ = $4,094.67Discounted payback period = 2 + ($10,800 - 3,693.69 - 3,895.79)/$4,094.67 = 2.78 years

Question 3

Project I has an initial cash outflow of $18,300 and annual cash flows of $8,700 for Years 1 to 3.Project II has an initial cash outflow of $25,400 and annual cash flows of $10,500 for Years 1 to 3.These projects are mutually exclusive.The required rate of return is 11 percent.Based on the incremental NPV_{(II - I),} which project(s)should be accepted and why?

Accepted Answer

Incremental cash flows:Time 0: -$25,400 - (-$18,300)= -$7,100Years 1 to 3: $10,500 - 8,700 = $1,800Incremental NPV_{(II - I)} = -$7,100 + $1,800/1.11 + $1,800/1.11² + $1,800/1.11³ = -$2,701.31NPV_I = -$18,300 + $8,700/1.11 + $8,700/1.11² + $8,700/1.11³ = $2,960.32

Question 4

Project A has an initial cost of $16,400 and cash flows of $5,100,$6,800,and $6,900 for Years 1 to 3,respectively.Project B has an initial cost of $21,200 and cash flows of $8,300,$7,900,and $7,700 for Years 1 to 3,respectively.What is the incremental IRR?

Accepted Answer

Incremental cash flows:Time 0: -$21,200 - (-$16,400)= -$4,800Year 1: $8,300 - 5,100 = $3,200Year 2: $7,900 - 6,800 = $1,100Year 3: $7,700 - 6,900 = $800Incremental IRR = -$4,800 + $3,200/(1 + IRR)+ $1,100/(1 + IRR)² + $800/(1 + IRR)³IRR = 4.07%

Question 5

A project has an initial cost of $32,000 and a 4-year life.The company uses straightline depreciation to a book value of zero over the life of the project.The projected net income from the project is $1,200,$2,200,$3,500,and $2,700 a year for Years 1 to 4,respectively.What is the average accounting return?

Accepted Answer

Average net income = ($1,200 + 2,200 + 3,500 + 2,700)/4 = $2,400Average book value = ($32,000 + 24,000 + 16,000 + 8,000 + 0)/5 = $16,000AAR = $2,400/$16,000 = .1500,or 15.00%

Question 6

Explain the differences and similarities between net present value (NPV)and the profitability index (PI).

Accepted Answer

The answer of Explain the differences and similarities between net...

Question 7

A project has average net income of $4,160 a year over its 4-year life.The initial cost of the project is $65,000 which will be depreciated using straightline depreciation to a zero book value over the life of the project.The firm wants to earn a minimal average accounting return of 11.65 percent.Should the project be accepted or rejected? What is the AAR?

Accepted Answer

Average book value = ($65,000 + 48,750 + 32,500 + 16,250 + 0)/5 = $32,500AAR = $4,160/$32,500 = .1280,or 12.80 percent

Question 8

Turner Enterprises is analyzing a project that is expected to have annual cash flows of $77,400,$21,300 and -$6,200 for Years 1 to 3,respectively.The initial cash outlay is $84,900 and the discount rate is 11 percent.What is the modified IRR?

Accepted Answer

Modified Year 2 cash flow = $21,300 + (-$6,200)/1.11 = $15,714.41Modified IRR: $0 = -$84,900 + $77,400/(1 + IRR)+ $15,714.41/(1 + IRR)² = 8.26%

Question 9

Clinton is considering a project that costs $3,200 will produce cash inflows of $980 a year for 4 years.The project has a required rate of return of 8.75 percent.What is the discounted payback period?

Accepted Answer

Discounted cash flows:Year 1 = $980/1.0875 = $901.15Year 2 = $980/1.0875² = $828.64Year 3 = $980/1.0875³ = $761.97Year 4 = $980/1.0875⁴ = $700.66Total discounted cash flows = $901.15 + 828.64 + 761.97 + 700.66 = $3,192.42The project never pays back on a discounted basis.

Question 10

A project is expected to have annual cash flows of $22,400,$13,600 and -$4,200 for Years 1 to 3,respectively.The initial cash outlay is $27,500 and the discount rate is 12 percent.What is the modified IRR?

Accepted Answer

Modified Year 2 cash flow = $13,600 + (-$4,200)/1.12 = $9,850Modified IRR: $0 = -$27,500 + $22,400/(1 + IRR)+ $9,850/(1 + IRR)² = 13.12%

Question 11

The Depot is considering a project with annual sales of $325,000 for four years.The profit margin is 4.65 percent.The initial cost for equipment will be $330,000.The equipment will be depreciated by $55,000 each year.The required average accounting rate of return is 11.4 percent.Should this project be accepted or rejected? What is the AAR?

Accepted Answer

Average net income $325,000 × .0465 = $15,112.50Average book value = ($330,000 + 275,000 + 220,000 + 165,000 + 110,000)/5 = $220,000AAR = $15,112.50/$220,000 = .0687,or 6.87%

Question 12

Leo is considering adding a deli to his general store.The remodeling expenses and shelving costs are estimated at $2,500.Deli sales are expected to produce net cash inflows of $1,300,$1,600,$1,700,and $1,750 for Years 1 to 4,respectively.Leo has a firm 3-year payback requirement.Should he add the deli?

Accepted Answer

Payback = 1 + ($2,500 - 1,300)/$1,600 = 1.75 years;Accept

Question 13

A project has an initial cash inflow of $95,500 and cash flows of -$48,700 in Year 1 and -$57,200 in Year 2.The discount rate is 9 percent.Should this project be accepted or rejected based on IRR? Why?

Accepted Answer

IRR = $95,500 + (-$48,700)/(1 + IRR)+ (-$57,200)/(1 + IRR)²IRR = 6.98%NPV = $95,500 - $48,700/1.09 - $57,200/1.09²NPV = $2,677.01Because this is a financing type project,the project should be accepted since the IRR of 6.98 percent is less than the discount rate of 9 percent.This is verified by the positive NPV at the 9 percent rate.

Question 14

Project A has an initial cost of $22,400 and cash flows of $7,100,$8,800,and $1,900 for Years 1 to 3,respectively.Project B has an initial cost of $37,200 and cash flows of $18,300,$17,900,and $2,700 for Years 1 to 3,respectively.What is the incremental IRR?

Accepted Answer

Incremental cash flows:Time 0: -$37,200 - (-$22,400)= -$14,800Year 1: $18,300 - 7,100 = $11,200Year 2: $17,900 - 8,800 = $9,100Year 3: $2,700 - 1,900 = $800Incremental IRR = -$14,800 + $11,200/(1 + IRR)+ $9,100/(1 + IRR)² + $800/(1 + IRR)³IRR = 27.31%

Question 15

A project has an initial cost of $2,600.The cash inflows are $300,$500,$900,and $700 for Years 1 to 4,respectively.What is the payback period?

Accepted Answer

Total cash flows = $300 + 500 + 900 + 700 = $2,400;The project never pays back.

Question 16

A project has an initial cash inflow of $36,400 and a cash outflow of $42,900 in Year 1.The discount rate is 20 percent.Should this project be accepted or rejected based on IRR? Why?

Accepted Answer

IRR = $36,400 + (-$42,900)/(1 + IRR)IRR = 17.86%NPV = $36,400 - $42,900/1.20NPV = $650Because this is a financing type project,the project should be accepted since the IRR of 17.86 percent is less than the discount rate of 20 percent.This is verified by the positive NPV at the 20 percent discount rate.

Question 17

Nadine always makes the final accept/reject decision for proposed projects for ARK International.Her final decision is always based on NPV.Why then does she insist that any proposed project that comes to her desk include an analysis of the project's NPV,IRR,PI,payback,and discounted payback?

Accepted Answer

The answer of Nadine always makes the final accept/reject decision...

Question 18

Webster's wants to introduce a new product that has a startup cost of $15,000.The product has a 2-year life and will provide cash flows of $12,700 in Year 1 and $6,300 in Year 2.The required rate of return is 10 percent.Should the product be introduced? Why or why not?

Accepted Answer

NPV = -$15,000 + $12,700/1.1 + $6,300/1.1² = $1,752.07PI = ($12,700/1.1 + $6,300/1.1²)/$15,000 = 1.12IRR = -$15,000 + $12,700/(1 + IRR)+ $6,300/(1 + IRR)²IRR = 19.74%

Question 19

The Walk-Up Window is considering two mutually exclusive projects.Project A has an initial cost of $49,230 and annual cash flows of $31,200 for three years.Project B has an initial cost of $21,400 and annual cash flows of $21,400 for two years.What is the crossover rate?

Accepted Answer

Incremental cash flows:Time 0: -$49,230 - (-$21,400)= -$27,830Year 1: $31,200 - 21,400 = $9,800Year 2: $31,200 - 21,400 = $9,800Year 3: $31,200 - 0 = $31,200Incremental IRR = -$27,830 + $9,800/(1 + IRR)+ $9,800/(1 + IRR)² + $31,200/(1 + IRR)³Incremental IRR = 29.39%

Question 20

Janice is considering an investment costing $102,500 with cash flows of $9,800 in Year 2,$48,700 in Year 3,and $82,900 in Year 4.The discount rate is 9 percent and the required discounted payback period is 2.5 years.Should this project be accepted or rejected? What is the discounted payback period?

Accepted Answer

Discounted cash flows:Year 1 = $0Year 2 = $9,800/1.09² = $8,248.46Year 3 = $48,700/1.09³ = $37,605.34Year 4 = $82,900/1.09⁴ = $58,728.45Discounted payback period = 3 + ($102,500 - 8,248.46 - 37,605.34)/$58,728.45 = 3.96 years

Quiz 7: Net Present Value and Other Investment Rules