CHAPTER 10 Capital Budgeting Problems - 19978

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 CHAPTER 10 Capital Budgeting Problems

 

 

 

Capital Budgeting Problems

 

1. Gander, Inc. is considering two projects with the following cash flows.

Year

Project X

Project Y

0

($100,000)

($100,000)

1

$40,000

$50,000

2

$40,000

$0

3

$40,000

$0

4

$40,000

$0

5

$40,000

$250,000

 

Gander uses the payback period method of capital budgeting and accepts only projects with payback periods of 3 years or less.

a. If the projects are presented as standalone opportunities which one( s) would Gander accept? If they were mutually exclusive and Gander disregarded its three year rule, which project would be chosen?

b. Is there a flaw in the thinking behind the correct answers to part a?

2. A project has the following cash flows

C0

C1

C2

C3

$(700)

$200

$500

$244

 

a. What is the projects payback period?

b. Calculate the projects NPV at 12%.

c. Calculate the projects PI at 12%.

4. Clancy Inc. is considering a project with the following cash flows.

C0

C1

C2

C3

$(7,800)

$2,300

$3,500

$4,153

 

a. Clancy has a policy of rejecting all projects that dont pay back within three years and analyzing those that do more carefully with time value based meth-ods. Does this project warrant further consideration?

b. Should Clancy accept the project based on its NPV if the companys cost of capital is 8%?

c. What conclusion will the firm reach based on PI?

6. Hamstring Inc. is considering a project with the following cash flows.

C0

C1

C2

C3

C4

$25,000

$10,000

$12,000

$5,000

$8,000

 

 

 

 

 

 

The company is reluctant to consider projects with paybacks of more than three years. If projects pass the payback screen, they are considered further by means of the NPV and IRR methods. The firms cost of capital is 9%.

a. What is the projects payback period? Should the project be considered further?

b. What is the projects NPV? Does NPV indicate acceptance on a stand- alone basis?

c. Calculate the projects IRR by using an iterative approach. Start by using the cost of capital and the NPV calculation from part ( a). Does IRR indicate acceptance on a stand- alone basis?

d. What is the projects PI? Does PI indicate acceptance on a stand- alone basis?

7. Project Alpha requires an initial outlay of $ 35,000 and results in a single cash inflow of $ 56,367.50 after five years.

a. If the cost of capital is 8%, what are Alphas NPV and PI? Is the project accept-able under each of these techniques?

b. What is project Alphas IRR? Is it acceptable under IRR?

c. What are Alphas NPV and PI if the cost of capital is 12%? Is the project acceptable under that condition?

d. What is Alphas payback period? Does payback make much sense for a project like Alpha? Why or why not?

8. The Sampson Company is considering a project that requires an initial outlay of $ 75,000 and produces cash inflows of $ 20,806 each year for five years. Sampsons cost of capital is 10%.

a. Calculate the projects payback period by making a single division rather than accumulating cash inflows. Why is this possible in this case?

b. Calculate the projects IRR, recognizing the fact that the cash inflows are an annuity. Is the project acceptable? Did your calculation in this part result in any number( s) that were also calculated in part ( a)? What is it about this prob-lem that creates this similarity? Will this always happen in such cases?

c. What is the projects NPV? Is the project acceptable according to NPV rules?

9. Calculate the IRR, NPV, and PI for projects with the following cash flows. Do each NPV and PI calculation at costs of capital of 8% and 12%. Calculate IRRs to the nearest whole percent.

a. An initial outlay of $ 5,000 and inflows of $ 1,050 for seven years.

b. An initial outlay of $ 43,500 and inflows of $ 14,100 for four years.

c. An investment of $ 78,000 followed by 12 years of income of $ 11,500.

d. An outlay of $ 36,423 followed by receipts of $ 8,900 for six years.

11. Calculate the NPV for the following projects.ject and justify your choice.f. Choose a project and justify your choice.

Solution Description

 

 

1.         Gander, Inc. is considering two projects with the following cash flows.

Year                             Project X                  &nb

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