Solved by verified expert :13. Aerospace Dynamics will invest $110,000 in a

project that will produce the following cash flows. The cost of capital is 11

percent. Should the project be undertaken? (Note that the fourth year’s cash

flow is negative.)

Year

Cash Flow

1…………….

$36,000

2…………….

44,000

3…………….

38,000

4…………….

(44,000)

5…………….

81,000

14. The Horizon Company will invest $60,000 in a

temporary project that will generate the following cash inflows for the next

three years.

Year

Cash Flow

1…………….

$15,000

2…………….

25,000

3…………….

40,000

The

firm will also be required to spend $10,000 to close down the project at the

end of the three years. If the cost of capital is 10 percent, should the

investment be undertaken?

15. Skyline Corp. will invest $130,000 in a

project that will not begin to produce returns until after the 3rd year. From

the end of the 3rd year until the end of the 12th year (10 periods), the annual

cash flow will be $34,000. If the cost of capital is 12 percent, should this

project be undertaken?

16. The Ogden Corporation makes an investment of

$25,000, which yields the following

cash flows:

Year

Cash Flow

1…………….

$ 5,000

2…………….

5,000

3…………….

8,000

4…………….

9,000

5…………….

10,000

a. What is the present value with a 9 percent

discount rate (cost of capital)?

b. What is the internal rate of return? Use

the interpolation procedure shown in this chapter.

c. In this problem would you make the same

decision in parts a and b

17. The Danforth Tire Company is considering the

purchase of a new machine that would increase the speed of manufacturing and

save money. The net cost of this machine is $66,000. The annual cash flows have

the following projections.

Year

Cash Flow

1…………….

$21,000

2…………….

29,000

3…………….

36,000

4…………….

16,000

5…………….

8,000

a. If the cost of capital is 10 percent, what

is the net present value?

b. What is the internal rate of return?

c. Should the project be accepted? Why?

18. You are asked to evaluate two projects for

Adventures Club, Inc. Using the net present value method combined with the

profitability index approach described in footnote 2 on page ____, which project

would you select? Use a discount rate of 12 percent.

Project X (trips to Disneyland)

($10,000 investment)

Project Y (international film festivals)

($22,000 investment)

Year

Cash Flow

Year

Cash Flow

1…………………………

$4,000

1……………………………

$10,800

2…………………………

5,000

2……………………………

9,600

3…………………………

4,200

3……………………………

6,000

4…………………………

3,600

4……………………………

7,000

19. Cablevision, Inc., will invest $48,000 in a

project. The firm’s discount rate (cost of capital) is 9 percent. The

investment will provide the following inflows.

1…………….

$10,000

2…………….

10,000

3…………….

16,000

4…………….

19,000

5…………….

20,000

The internal rate of return is 15 percent.

a. If the reinvestment assumption of the net

present value method is used, what will be the total value of the inflows after

five years? (Assume the inflows come at the end of each year.)

b. If the reinvestment assumption of the

internal rate of return method is used, what will be the total value of the

inflows after five years?

c. Generally is one investment assumption

likely to be better than another?

20. The 21st Century Corporation uses the

modified internal rate of return. The firm has a cost of capital of 8 percent.

The project being analyzed is as follows ($20,000 investment):

Year

Cash Flow

1…………….

$10,000

2…………….

9,000

3…………….

6,800

a. What is the modified internal rate of

return? An approximation from Appendix B is adequate. (You do not need to

interpolate.)

b. Assume the traditional internal rate of

return on the investment is 14.9 percent. Explain why your answer in part a would be lower.

21. Oliver Stone and Rock Company uses a process

of capital rationing in its decision making. The firm’s cost of capital is 12

percent. It will invest only $80,000 this year. It has determined the internal

rate of return for each of the following projects.

Project

Project Size

Percent of Internal Rate of Return

A…………………….

$15,000

14%

B……………………..

25,000

19

C……………………..

30,000

10

D…………………….

25,000

16.5

E……………………..

20,000

21

F……………………..

15,000

11

G…………………….

25,000

18

H…………………….

10,000

17.5

a. Pick out the projects that the firm should

accept.

b. If Projects B and G are mutually

exclusive, how would that affect your overall answer? That is, which projects

would you accept in spending the $80,000?

22. Miller Electronics is considering two new

investments. Project C calls for the purchase of a coolant recovery system.

Project H represents an investment in a heat recovery system.

The firm wishes to use a net present value profile in comparing the projects.

The investment and cash flow patterns are as follows:

Project C ($25,000 Investment)

Project H ($25,000 investment)

Year

Cash Flow

Year

Cash Flow

1……………………..

$ 6,000

1………………………….

$20,000

2……………………..

7,000

2………………………….

6,000

3……………………..

9,000

3………………………….

5,000

4……………………..

13,000

a. Determine the net present value of the

projects based on a zero discount rate.

b. Determine the net present value of the

projects based on a 9 percent discount rate.

c. The internal rate of return on Project C

is 13.01 percent, and the internal rate of return on Project H is 15.68

percent. Graph a net present value profile for the two investments similar to

Figure 12-3. (Use a scale up to $10,000 on the vertical axis, with $2,000

increments. Use a scale up to 20 percent on the horizontal axis, with

5 percent increments.)

d. If the two projects are not mutually

exclusive, what would your acceptance or rejection decision be if the cost of

capital (discount rate) is 8 percent? (Use the net present value profile for

your decision; no actual numbers are necessary.)

e. If the two projects are mutually exclusive

(the selection of one precludes the selection of the other), what would be your

decision if the cost of capital is (1) 5 percent,

(2) 13 percent, (3) 19 percent? Use the net present value profile for your

answer.

23. Software Systems is considering an

investment of $20,000, which produces the following inflows:

Year

Cash Flow

1…………….

$11,000

2…………….

9,000

3…………….

5,800

You

are going to use the net present value profile to approximate the value for the

internal rate of return. Please follow these steps:

a. Determine the net present value of the

project based on a zero discount rate.

b. Determine the net present value of the

project based on a 10 percent discount rate.

c. Determine the net present value of the

project based on a 20 percent discount rate

(it will be negative).

d. Draw a net present value profile for the

investment. (Use a scale up to $6,000 on the vertical axis, with $2,000

increments. Use a scale up to 20 percent on the horizontal axis, with 5 percent

increments.) Observe the discount rate at which the net present value is zero.

This is an approximation of the internal rate of return on the project.

e. Actually compute the internal rate of

return based on the interpolation procedure presented in this chapter. Compare

your answers in parts d and e.

24. Howell Magnetics Corporation is going to

purchase an asset for $400,000 that will produce $180,000 per year for the next

four years in earnings before depreciation and taxes. The asset will be

depreciated using the three-year MACRS depreciation schedule in Table 12-9.

(This represents four years of depreciation based on the half-year convention.)

The firm is in a 34 percent tax bracket. Fill in the schedule below for the

next four years. (You need to first determine annual depreciation.)

Earnings

before depreciation and taxes

_____

Depreciation

_____

Earnings before taxes

_____

Taxes

_____

Earnings after taxes

_____

+ Depreciation

_____

Cash

flow

_____

25. Assume $80,000 is going to be invested in

each of the following assets. Using Tables 12-8 and 12-9, indicate the dollar

amount of the first year’s depreciation.

a. Computers

b. Petroleum refining product

c. Office furniture

d. Pipeline distribution

26. The Keystone Corporation will purchase an

asset that qualifies for three-year MACRS depreciation. The cost is $60,000 and

the asset will provide the following stream of earnings before depreciation and

taxes for the next four years:

Year 1……………… $27,000

Year 2……………… 30,000

Year 3……………… 23,000

Year 4……………… 15,000

The firm is in a 36

percent tax bracket and has an 11 percent cost of capital. Should it purchase

the asset?

27. Oregon Forest Products will acquire new

equipment that falls under the five-year MACRS category. The cost is $300,000.

If the equipment is purchased, the following earnings before depreciation and

taxes will be generated for the next six years.

Year 1………………… $112,000

Year 2………………… 105,000

Year 3………………… 82,000

Year 4………………… 53,000

Year 5………………… 37,000

Year 6………………… 32,000

The firm is in a 30

percent tax bracket and has a 14 percent cost of capital. Should Oregon Forest

Products purchase the equipment? Use the net present value method.

28. The Thorpe Corporation is considering the

purchase of manufacturing equipment with a 10-year midpoint in its asset

depreciation range (ADR). Carefully refer to Table 12-8 to determine in what

depreciation category the asset falls. (Hint: It is not 10 years.) The asset

will cost $80,000, and it will produce earnings before depreciation and taxes

of $28,000 per year for three years, and then $12,000 a year for seven more

years. The firm has a tax rate of 34 percent. With a cost of capital of 12

percent, should it purchase the asset? Use the net present value method. In

doing your analysis, if you have years in which there is no depreciation,

merely enter a zero for depreciation.