HADM 2250 Prelim Review Questions
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1. What is the payback period for the set of cash flows given below?
Year
|
Cash Flow
|
0
|
–$5,500
|
1
|
1,300
|
2
|
1,500
|
3
|
1,900
|
4
|
1,400
|
2. An investment project provides cash inflows of $585 per year for eight years.
(a) What is the project payback period if the initial cost is $1,700? (b) What is the project payback period if the initial cost is $3,300? (c) What is the project payback period if the initial cost is $4,900?
3. Buy Coastal, Inc., imposes a payback cutoff of three years for its international investment projects.
Year
|
Cash Flow (A)
|
Cash Flow (B)
|
0
|
–$60,000
|
–$70,000
|
1
|
23,000
|
15,000
|
2
|
28,000
|
18,000
|
3
|
21,000
|
26,000
|
4
|
8,000
|
230,000
|
(a) What is the payback period for both projects? (b) Which project should the company accept?
4. An investment project has annual cash inflows of $3,200, $4,100, $5,300, and $4,500, and a discount rate of 14 percent.
(a) What is the discounted payback period for these cash flows if the initial cost is $5,900? (b) What is the discounted payback period for these cash flows if the initial cost is $8,000? (c) What is the discounted payback period for these cash flows if the initial cost is $11,000?
5. An investment project costs $10,000 and has annual cash flows of $2,900 for six years. (a) What is the discounted payback period if the discount rate is zero percent?
(b) What is the discounted payback period if the discount rate is 5 percent?
(c) What is the discounted payback period if the discount rate is 19 percent?
6. You’re trying to determine whether to expand your business by building a new manufacturing plant.
The plant has an installation cost of $12 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $1,854,300, $1,907,600, $1,876,000, and
$1,329,500 over these four years, what is the project’s average accounting return (AAR)?
7. A firm evaluates all of its projects by applying the IRR rule. A project under consideration has the following cash flows:
Year
|
Cash Flow
|
0
|
–$28,000
|
1
|
12,000
|
2
|
15,000
|
3
|
11,000
|
(a) If the required return is 14 percent, what is the IRR for this project? (b) Should the firm accept the following project?
8. A project that provides annual cash flows of $17,300 for nine years costs $79,000 today. (a) What is the NPV for the project if the required return is 8 percent?
(b) At a required return of 8 percent, should the firm accept this project? (c) What is the NPV for the project if the required return is 20 percent? (d) At a required return of 20 percent, should the firm accept this project?
(e) At what discount rate would you be indifferent between accepting the project and rejecting it?
9. A project has the following cash flows:
Year
|
Cash Flow
|
0
|
–$16,400
|
1
|
7,100
|
2
|
8,400
|
3
|
6,900
|
(a) What is the NPV at a discount rate of zero percent? (b) What is the NPV at a discount rate of 10 percent? (c) What is the NPV at a discount rate of 20 percent? (d) What is the NPV at a discount rate of 30 percent?
10. Consider the following two mutually exclusive projects:
Year
|
Cash Flow (X)
|
Cash Flow (Y)
|
0
|
–$20,000
|
–$20,000
|
1
|
8,850
|
10,100
|
2
|
9,100
|
7,800
|
3
|
8,800
|
8,700
|
(a) Calculate the IRR for each project.
(b) What is the crossover rate for these two projects?
(c) What is the NPV of Projects X and Y at discount rates of 0%, 15%, and 25%?
11. Consider the project with the following cash flows.
Year
|
Cash Flow
|
0
|
–$18,000
|
1
|
10,300
|
2
|
9,200
|
3
|
5,700
|
(a) What is the profitability index for the set of cash flows if the relevant discount rate is 10%? (b) What is the profitability index for the set of cash flows if the relevant discount rate is 15%? (c) What is the profitability index for the set of cash flows if the relevant discount rate is 22%?
12. The Angry Bird Corporation is trying to choose between the following two mutually exclusive design projects:
Year
|
Cash Flow (I)
|
Cash Flow (II)
|
0
|
–$64,000
|
–$18,000
|
1
|
31,000
|
9,700
|
2
|
31,000
|
9,700
|
3
|
31,000
|
9,700
|
(a) If the required return is 10 percent, what is the profitability index for both projects? If the company applies the profitability index decision rule, which project should the firm accept?
(b) What is the NPV for both projects? If the company applies the NPV decision rule, which project should it take?
13. An investment has an installed cost of $527,800. The cash flows over the four-year life of the investment are projected to be $221,850, $238,450, $205,110, and $153,820.
(a) If the discount rate is zero, what is the NPV?
(b) If the discount rate is infinite, what is the NPV?
(c) At what discount rate is the NPV just equal to zero?
14. Consider the project with the following cash flows
Year
|
Cash Flow
|
0
|
–$3,024
|
1
|
17,172
|
2
|
–36,420
|
3
|
34,200
|
4
|
–12,000
|
This problem is useful for testing the ability of financial calculators and computer software.
(a) How many IRRs are there for this series of cash flows.
(b) List the IRRs, from smallest to largest. (Hint: search between 20 percent and 70 percent.)
15. The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry
M. Deep, business is "looking up". As a result, the cemetery project will provide a net cash inflow of
$97,000 for the firm during the first year, and the cash flows are projected to grow at a rate of 4 percent per year forever. The project requires an initial investment of $1,500,000.
(a) What is the NPV for the project if Yurdone's required return is 11 percent? If Yurdone requires an 11 percent return on such undertakings, should the firm accept or reject the project?
(b) The company is somewhat unsure about the assumption of a 4 percent growth rate in its cash flows. At what constant growth rate would the company just break even if it still required an
11 percent return on investment?
16. A project has the following cash flows:
Year
|
Cash Flow
|
0
|
$42,000
|
1
|
–21,000
|
2
|
–32,000
|
(a) What is the IRR for this project?
(b) What is the NPV of this project, if the required return is 12 percent? (c) What is the NPV of the project if the required return is 0 percent? (d) What is the NPV of the project if the required return is 24 percent?
17. Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows:
Year
|
Cash Flow
|
0
|
–$1,250,000
|
1
|
425,000
|
2
|
490,000
|
3
|
385,000
|
4
|
340,000
|
All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has declared that all cash flows created by a foreign company are “blocked” and must be reinvested with the government for one year. The reinvestment rate for these funds is 4 percent.
If Anderson uses an 11 percent required return on this project, what are the NPV and IRR of the project?
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