1. Calculate the payback and profitability index. The maximum payback period is 2 years and the cost of capital is 12%.
|
Project
|
Time 0
|
1
|
2
|
3
|
|
Fun Time
|
-1000
|
950
|
400
|
-225
|
|
Clock Works
|
-500
|
550
|
0
|
0
|
|
Bug Hugs
|
-1100
|
500
|
500
|
500
|
a. If the projects are independent, which one(s) do you select? Why?
b. If they are mutually exclusive, which one would you prefer? Why?
2. Top Inc. is interested in developing a new toy. The toys will sell for $25 each and they plan to sell 10 million toys at the end of each year for 4 years. Variable costs are $20 per toy; fixed costs are $10,000,000 per year. The interest expense is $3,000,000 per year. The project requires an additional machine that costs $120,000,000 to be depreciated to a zero book value on a straight-line basis over 4 years. The machine has a salvage value of $20,000,000. The tax rate is 40%. The initial investment in net working capital is $5,000,000. No additional net working capital is needed for the project and no net working capital will be returned. The variable and fixed costs do not include the depreciation and the interest expenses. There is no horizon value.
a. If the cost of capital is 8%, find the net present value.
b. Find the internal rate of return.
c. Do you accept the project? Explain.