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 yearâs 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 firmâs 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 firmâs 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 yearâs 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.
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