Exercise 1:
Describe what is the NPV of a project that costs $100,000 and returns $50,000 annually for three years if the opportunity cost of capital is 14%?
Exercise 2:
What is the approximate maximum amount that a firm should consider paying for a project that will return $15,000 annually for 5 years if the opportunity cost is 10%?
Exercise 3:
What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for six years?
Exercise 4:
Alliance Corp is considering making an investment of $500 million. It is evaluating two mutually exclusive projects. Each project has a 15 year life. The Gamma project will produce cash flows of $80 million every year for the next 15 years. The Rho project will produce cash flows of $50 million for the first three years, $90 million for the next two years, $120 million for the next five years and $80 million for the last five years. Both projects are perceived to be equally risky and Alliance Corp expects at least a 14% return from the projects.
a. Evaluate the payback period for each project. Which project would you select based on the payback period? Why?
b. Find the NPV for each project. Which project would you select based on the NPV? Why?
c. Evaluate the internal rate of return for each project. Which project would you select based on the internal rate of return? Why?
Exercise 5:
Reactive Industries has the following capital structure. Its corporate tax rate is 35 percent. What is the weighted average cost of capital?
Security Market Value Required Rate of Return
Debt
Preferred Stock
Common Stock $20 million
10 million
50 million 6%
8
12