Critical Thinking Assignment
Question 1: Future values and annuities
1. The cost of a new automobile is $10,000. If the interest rate is 5%, how much would you have to set aside now to provide this sum in five years?
2. You have to pay $12,000 a year in school fees at the end of each of the next six years. If the interest rate is 8%, how much do you need to set aside today to cover these bills?
3. You have invested $60,476 at 8%. After paying the above school fees, how much would remain at the end of the six years?
Question 2: IRR rule
Consider the following two mutually exclusive projects:
| Cash Flows($) |
| Project |
C0 |
C1 |
C2 |
C3 |
| A |
-100 |
+60 |
+60 |
0 |
| B |
-100 |
0 |
0 |
+140 |
1. Calculate the NPV of each project for discount rates of 0%, 10%, and 20%.
2. What is the approximate IRR for each project?
3. In what circumstances should the company accept project A?
4. Calculate the NPV of the incremental investment (B - A) for discount rates of 0%, 10%, and 20%. What can you conclude?
Question 3: IRR rule
The TTL Shipbuilding Company has a noncancelable contract to build a small cargo vessel. Construction involves a cash outlay of $250,000 at the end of each of the next two years. At the end of the third year the company will receive payment of $650,000. The company can speed up construction by working an extra shift. In this case, there will be a cash outlay of $550,000 at the end of the first year followed by a cash payment of $650,000 at the end of the second year. Use the IRR rule to show the (approximate) range of opportunity costs of capital at which the company should work the extra shift.
Question 4: Capital Rationing
BGMT Pharmaceuticals has $1 million allocated for capital expenditures. Which of the following projects should the company accept to stay within the $1 million budget? How much does the budget limit cost the company in terms of its market value? The opportunity cost of capital for each project is 11%.
| Project |
Investment ($thousands) |
NPV ($ thousands) |
IRR (%) |
| 1 |
300 |
66 |
17.2 |
| 2 |
200 |
-4 |
10.7 |
| 3 |
250 |
43 |
16.6 |
| 4 |
100 |
14 |
12.1 |
| 5 |
100 |
7 |
11.8 |
| 6 |
350 |
63 |
18 |
| 7 |
400 |
48 |
13.5 |
Your paper should be one to two pages in length (excluding cover page and references) and formatted according to the CSU-Global Guide to Writing and APA Requirements. Be sure to discuss and reference concepts taken from the assigned textbook reading and relevant research.