Problem 1: Long-term investment decision, payback method Bill Williams has the opportunity to invest in project A that costs $9,000 today and promises to pay annual end-ofyear payments of $2,200, $2,500, $2,500, $2,000, and $1,800 over the next 5 years. Or, Bill can invest $9,000 in project B that promises to pay annual end-of-year payments of $1,500, $1,500, $1,500, $3,500, and $4,000 over the next 5 years.
a. How long will it take for Bill to recoup his initial investment in project A?
b. How long will it take for Bill to recoup his initial investment in project B?
c. Using the payback period, which project should Bill choose?
d. Do you see any problems with his choice?
Problem 2: NPV: Mutually exclusive projects I-look Industries is considering the rcplaccmcnt of one of its old drill presses. Three alternative rcplaccmcnt presses arc under consider-ation. The relevant cash flows associated with each are shown in the following table. The firm's cost of capital is 15%.
|
|
Press A
|
Press B
|
Press C
|
|
Initial investment (CF0)
|
$85,000
|
$60,000
|
$130,000
|
|
Year (t)
|
Cash inflows (CF,)
|
|
|
1
|
$18,000
|
$12,000
|
$50,000
|
|
2
|
18,000
|
14,000
|
30,000
|
|
3
|
18,000
|
16,000
|
20,000
|
|
4
|
18,000
|
18,000
|
20,000
|
|
5
|
18,000
|
20,000
|
20,000
|
|
6
|
18,000
|
25,000
|
30,000
|
|
7
|
18,000
|
-
|
40,000
|
|
8
|
18,000
|
-
|
50,000
|
a. Calculate the net present value (NPV) of each press.
b. Using NPV, evaluate the acceptability of each press.
c. Rank the presses from but to worst using NPV.
d. Calculate the profitability index (P1) for each press.
e. Rank the presses from but to worst using Pl.
Problem 3: Long-term investment decision, NPV method Jenny Jenks has researched the financial pros and cons of entering into a 1-year MBA program at her state university. The tuition and books for the master’s program will have an up-front cost of $50,000. If she enrolls in an MBA program, Jenny will quit her current job, which pays $50,000 per year after taxes (for simplicity, treat any lost earnings as part of the up-front cost). On average, a person with an MBA degree earns an extra $20,000 per year (after taxes) over a business career of 40 years. Jenny believes that her opportunity cost of capital is 6%. Given her estimates, find the net present value (NPV) of entering this MBA program. Are the benefits of further education worth the associated costs?
Problem 4: Internal rate of return Peace of Mind, Inc. (PMI), sells extended warranties for durable consumer goods such as washing machines and refrigerators. When PMI sells an extended warranty, it receives cash up front from the customer, but later PMI must cover any repair costs that arise. An analyst working for PMI is considering a warranty for a new line of big-screen TVs. A consumer who purchases the 2-year warranty will pay PMI $200. On average, the repair costs that PMI must cover will average $106 for each of the warranty’s 2 years. If PMI has a cost of capital of 7%, should it offer this warranty for sale?
Problem 5:
All techniques, conflicting rankings Nicholson Roofing Materials, Inc., is consider¬ing two mutually exclusive projects, each with an initial investment of $150,000. The company's board of directors has set a maximum 4-year payback requirement and has set its cost of capital at 9%. The cash inflows associated with the two proj¬ects arc shown in the following table
|
Year
|
Cash inflows (CF,)
|
|
Project A
|
Project B
|
|
1
|
$45,000
|
575,000
|
|
2
|
45,000
|
60,001
|
|
3
|
45,000
|
30,000
|
|
4
|
45,000
|
30,000
|
|
5
|
45,000
|
30,000
|
|
6
|
45,000
|
30,000
|
a. Calculate the payback period for each project.
b. Calculate the NPV of each project at 0%.
c. Calculate the NPV of each project at 9%.
d. Dcrivc the IRR of each project.
e. Rank the projects by each of the techniques used. Make and justify a recommen-dation.
f. Go back one more time and calculate the NPV of each project using a cost of capital of 12%. Does the ranking of the two projects change compared to your answer in part e? Why?