1.Your firm spends $500,000 per year in regular maintenance of its equipment. Due to the economic downturn, the firm considers forgoing these maintenance expenses for the next three years. If it does so, it expects it will need to spend $2 million in year 4 replacing failed equipment.
a. What is the IRR of the decision to forgo maintenance of the equipment?
b. Does the IRR rule work for this decision?
c. For what costs of capital is forgoing maintenance a good decision?
2.Your firm has been hired to develop new software for the university’s class registration system. Under the contract, you will receive $500,000 as an upfront payment. You expect the place, you will receive a final payment of $900,000 from the university four years from now.
a. What are the IRRs of this opportunity?
b. If your cost of capital is 10%, is the opportunity attractive? Suppose you are able to renegotiate the terms of the contract so that your final payment in year 4 will be $1 million.
c. What is the IRR of the opportunity now?
d. Is it attractive at these terms?
3.You are considering constructing a new plant in a remote wilderness area to process the ore from a planned mining operation. You anticipate that the plant will take a year to build and cost $100 million upfront. Once built, it will generate cash flows of $15 million at the end of every year over the life of the plant. The plant will be useless 20 years after its completion once the mine runs out of ore. At that point you expect to pay $200 million to shut the plant down and restore the area to its pristine state. Using a cost of capital of 12%,
a. What is the NPV of the project?
b. Is using the IRR rule reliable for this project? Explain.
c. What are the IRR’s of this project?
4.You are a real estate agent thinking of placing a sign advertising your services at a local bus stop. The sign will cost $5000 and will be posted for one year. You expect that it will generate additional revenue of $500 per month. What is the payback period?