1. Suppose Palmer Properties is considering investing $2 million today (i.e., C0 = -2,000,000) on a new project that is expected to last for 8 years. The project is expected to generate annual cash flows of C1 = -250,000; C2 = 350,000, C3 = 500,000 and then $600,000 for period C4 through C8. If the discount rate is 10% and management’s payback period cutoff is 5 years:
(a) What is the payback period for the project? Show your work
(b) What is the net present value of the project ? Show your work
(c) What is the internal rate of return on the project ? Show your work
(d) Under which method(s) above should the company accept the project (applying the acceptance rules)? Explain
2. The company is choosing between machine A and B (they are mutually exclusive and the company can only pick one). The initial cost of machine A is $300,000 and it will last for 7 years before it needs to be replaced. The cost of operating machine A each year is $50,000. The initial cost of Machine B is $180,000 and it will last for 5 years before it needs to be replaced. The cost of operating machine B is $70,000 in cash flow per year. If the required rate of return is 9%,
(a) Calculate the 7 year and 5 year annuity factors at 9% annual interest.
(b) Using the annuity factors, find the PV of Machine A and Machine B including all costs (initial + operating).
(c) Which machine is a better choice for the company after considering the different lives of the projects? (Note: be sure to use the equivalent annual annuity method)
3. BMT has developed a new product. It can go into production for an initial investment of $5,000,000. The equipment will be depreciated using straight-line depreciation over 4 years to a value of zero. The firm believes that net working capital at each date will equal 20 percent of next year’s forecast sales. The firm estimates that variable costs are equal to 45% of sales and fixed costs are $400,000 per year. Sales forecasts in dollars are below. The project will come to an end after 4 years, when the product becomes obsolete. The firm’s tax rate is 35 percent, and the discount rate is 8 percent. Calculate the NPV.
Year 0 1 2 3 4
Sales forecast (in $): 0 3,000,000 3,500,000 4,000,000 4,500,000
4. In problem 3, perform sensitivity analysis on the following assumptions and find the revised NPV
(a) sales are 10% lower each year than predicted above
(b) the discount rate is 12 percent