NR 439 Week 3 Research Database Assignment Form: HADM 2250 Prelim Review Questions

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?

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?

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?

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?

18. Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $5 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company would net $5.3 million. The company

wants to build its new manufacturing plant on this land; the plant will cost $12.5 million to build, and the site requires $770,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project?

19. Winnebagel Corp. currently sells 30,000 motor homes per year at $68,000 each, and 12,000 luxury motor coaches per year at $105,000 each. The company wants to introduce a new portable camper to fill out its product line; it hopes to sell 25,000 of these campers per year at $14,000 each. An independent consultant has determined that if Winnebagel introduces the new campers, it should boost the sales of its existing motor homes by 2,400 units per year, and reduce the sales of its motor

coaches by 1,100 units per year. What is the amount to use as the annual sales figure when evaluating this project?

20. A proposed new investment has projected sales of $750,000. Variable costs are 55 percent of sales, and fixed costs are $164,000; depreciation is $65,000. Prepare a pro forma income statement assuming a tax rate of 35 percent. That is, determine the Sales, Variable Costs, Fixed Costs, Depreciation, EBIT, Taxes, and Net Income.

21. Consider the following income statement.

Sales $682,900

Costs $427,800

Depreciation $110,400

EBIT $

Taxes (34%) $

Net Income $

(a) Fill in the missing numbers for the following income statement

(b) Calculate the OCF.

22. A proposed new project has projected sales of $125,000, costs of $59,000, and depreciation of

$12,800. The tax rate is 35 percent. Calculate operating cash flow using the four different approaches

(a) EBIT + Depreciation – Taxes

(b) Top-Down (c) Tax-Shield (d) Bottom-Up

Is the answer the same in each case?

23. A piece of newly purchased industrial equipment costs $975,000 and is classified as seven-year property under MACRS. The MACRS depreciation schedule is shown in Table 10.7 in the textbook. For your convenience, the relevant MACRS values has been provided. Calculate the annual depreciation allowances and end-of-the-year book values for this equipment.

Year	Beginning Book Value	MACRS	Depreciation	Ending Book Value
1		0.1429
2		0.2449
3		0.1749
4		0.1249
5		0.0893
6		0.0892
7		0.0893
8		0.0446

24. Consider an asset that costs $640,000 and is depreciated straight-line to zero over its eight-year tax life. The asset is to be used in a five-year project; at the end of the project, the asset can be sold for

$175,000. If the relevant tax rate is 35 percent, what is the aftertax cash flow from the sale of this

asset?

25. An asset used in a four-year project falls in the five-year MACRS class for tax purposes. The asset has an acquisition cost of $6,100,000 and will be sold for $1,300,000 at the end of the project. If the

tax rate is 35 percent, what is the aftertax salvage value of the asset? Refer to Table 10.7 in the textbook.

26. Your firm is contemplating the purchase of a new $580,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $60,000 at the end of that time. You will save $210,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $75,000 (this is a one-time reduction). If the tax rate is 35 percent, what is the IRR for this project?

27. Your firm is contemplating the purchase of a new $580,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $60,000 at the end of that time. You will be able to reduce working capital by $75,000 (this is a one-time reduction). The tax rate is 35 percent and the required return on the project is 15 percent.

(a) If the pretax cost savings are $200,000 per year, what is the NPV of this project? (b) If the pretax cost savings are $150,000 per year, what is the NPV of this project? (c) Which project would you accept?

(d) At what level of pretax cost savings would you be indifferent between accepting the project and not accepting it?

28. Purple Haze Machine Shop is considering a four-year project to improve its production efficiency.

Buying a new machine press for $470,000 is estimated to result in $190,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage value at the end of the project of $80,000. The press also requires an initial investment in spare parts inventory of

$20,000, along with an additional $2,500 in inventory for each succeeding year of the project. The

shop’s tax rate is 35 percent and its discount rate is 9 percent. Refer to Table 10.7 in Textbook. Calculate the NPV of this project. Should the company buy and install the machine press?

29. You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ), manufacturers of fine zithers. The market for zithers is growing quickly. The company bought some land three years ago for $1.4 million in anticipation of using it as a toxic waste dump site but has recently hired another company to handle all toxic materials. Based on a recent appraisal, the company believes it could sell the land for $1.5 million on an aftertax basis. In four years, the land could be sold for $1.6 million after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of

$125,000. An excerpt of the marketing report is as follows:

The zither industry will have a rapid expansion in the next four years. With the brand name recognition that PUTZ brings to bear, we feel that the company will be able to sell 3,800, 4,700,

5,300, and 4,200 units each year for the next four years, respectively. Again, capitalizing on the name

recognition of PUTZ, we feel that a premium price of $650 can be charged for each zither. Because zithers appear to be a fad, we feel at the end of the four-year period, sales should be discontinued.

PUTZ believes that fixed costs for the project will be $425,000 per year, and variable costs are 15 percent of sales. The equipment necessary for production will cost $3.5 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can

be scrapped for $400,000. Net working capital of $125,000 will be required immediately. PUTZ has a

38 percent tax rate, and the required return on the project is 13 percent. Refer to Table 10.7. What is the NPV of the project?

30. Aguilera Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emulation implant as follows:

Year	Unit Sales
1	81,000
2	94,000
3	108,000
4	103,000
5	84,000

Production of the implants will require $1,600,000 in net working capital to start and additional net working capital investments each year equal to 15 percent of the projected sales increase for the following year. Total fixed costs are $1,500,000 per year, variable production costs are $265 per unit, and the units are priced at $380 each. The equipment needed to begin production has an installed cost of $21,000,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 20 percent of its acquisition cost. AAI is in the 35 percent marginal tax bracket and has a required return on all its projects of 18 percent. Refer to Table 10.7 in textbook.

What is the NPV of the project? What is the IRR?

31. A five-year project has an initial fixed asset investment of $310,000, an initial NWC investment of

$30,000, and an annual OCF of −$29,000. The fixed asset is fully depreciated over the life of the project and has no salvage value. If the required return is 11 percent, what is this project’s equivalent annual cost, or EAC?

32. Lang Industrial Systems Company (LISC) is trying to decide between two different conveyor belt systems. System A costs $240,000, has a four-year life, and requires $75,000 in pretax annual operating costs. System B costs $340,000, has a six-year life, and requires $69,000 in pretax annual operating costs. Whichever project is chosen, LISC always needs a conveyor belt system; when one wears out, it must be replaced. Assume the tax rate is 34 percent and the discount rate is 8 percent.

(a) Calculate the EAC for both conveyor belt systems. (b) Which conveyor belt system should the firm choose?

33. Vandalay Industries is considering the purchase of a new machine for the production of latex.

Machine A costs $3,100,000 and will last for six years. Variable costs are 35 percent of sales, and fixed costs are $240,000 per year. Machine B costs $5,300,000 and will last for nine years. Variable costs for this machine are 30 percent of sales and fixed costs are $175,000 per year. The sales for each machine will be $11 million per year. The required return is 10 percent, and the tax rate is 35 percent. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis.

(a) Calculate the NPV and EAC for each machine. (b) Which machine should you choose?

34. Olin Transmissions, Inc., has the following estimates for its new gear assembly project: price =

$1,400 per unit; variable costs = $220 per unit; fixed costs = $3.9 million; quantity = 85,000 units.

Suppose the company believes all of its estimates are accurate only to within ±15 percent. What

values should the company use for the four variables given here when it performs its best-case scenario analysis? What about the worst-case scenario?

Scenario	Unit Sales	Unit Price	Unit Variable Cost	Fixed Cost
Base
Best
Worse

35. We are evaluating a project that costs $924,000, has an eight-year life, and has no salvage value.

Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at

75,000 units per year. Price per unit is $46, variable cost per unit is $31, and fixed costs are $825,000

per year. The tax rate is 35 percent, and we require a 15 percent return on this project.

(a) Calculate the accounting break-even point.

(b) What is the degree of operating leverage at the accounting break-even point?

(d) What is the sensitivity of NPV to changes in the sales (ΔNPV/ΔQ) figure?

(e) What is the sensitivity of OCF to changes in the variable cost (ΔOCF/ΔVC) figure?

36. In each of the following cases, calculate the accounting break-even and the cash break-even points.

Ignore any tax effects in calculating the cash break-even.

Case	Unit Price	Unit Variable Cost	Fixed Costs	Depreciation
(a)	$3,020	$2,275	$9,000,000	$3,100,000
(b)	46	41	73,000	150,000
(c)	11	4	1,700	930

37. In each of the following cases, find the unknown variable

Accounting Break-Even	Unit Price	Unit Variable Cost	Fixed Costs	Depreciation
112,800	$39	30	$820,000
165,000		27	3,200,000	1,150,000
4,385	92		160,000	105,000

38. A project has the following estimated data: price = $62 per unit; variable costs = $41 per unit;

fixed costs = $15,500; required return = 12 percent; initial investment = $24,000; life = four years.

(a) Ignoring the effect of taxes, what is the accounting break-even quantity? (b) What is the cash break-even quantity?

(d) What is the degree of operating leverage at the financial break-even level of output?

39. Consider a project with the following data: accounting break-even quantity = 13,400 units;

cash break-even quantity = 10,600 units; life = five years; fixed costs = $150,000;

variable costs = $24 per unit; required return = 12 percent.

Ignoring the effect of taxes, find the financial break-even quantity.

40. Consider a four-year project with the following information:

Initial fixed asset investment = $420,000; Straight-line depreciation to zero over the four-year life;

Zero salvage value; Price = $25;

Variable costs = $16; Fixed costs = $180,000; Quantity sold = 75,000 units; Tax rate = 34 percent;

(a) What is the degree of operating leverage at the given level of output?

(b) What is the degree of operating leverage at the accounting break-even level of output? (c) How sensitive is OCF to changes in quantity sold? That is, what is ΔOCF/ΔQ?

41. McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $825 per set and have a variable cost of $395 per set. The company has spent $150,000 for a marketing study that determined the company will sell 55,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,000 sets of its high-priced clubs. The high-priced clubs sell at $1,100 and have variable costs of $650. The company will also increase sales of its cheap clubs by 12,000 sets. The cheap clubs sell for $410 and have variable costs of $185 per set. The fixed costs each year will be $9,200,000. The company has also spent $1,000,000 on research and development for the new clubs. The plant and equipment required will cost $29,400,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,400,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 10 percent.

Suppose you feel that the values are accurate to within only ±10 percent. What are the best-case and worst-case NPVs? (Hint: The price and variable costs for the two existing sets of clubs are known with certainty; only the sales gained or lost are uncertain.)

42. McGilla Golf would like to know the sensitivity of NPV to changes in the price of the new clubs and the quantity of new clubs sold. The clubs will sell for $825 per set and have a variable cost of $395 per set. The company has spent $150,000 for a marketing study that determined the company will sell

55,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 10,000 sets of its high-priced clubs. The high-priced clubs sell at $1,100 and have variable costs of $650. The company will also increase sales of its cheap clubs by 12,000 sets. The cheap clubs sell for $410 and have variable costs of $185 per set. The fixed costs each year will be $9,200,000.

The company has also spent $1,000,000 on research and development for the new clubs. The plant and equipment required will cost $29,400,000 and will be depreciated on a straight-line basis. The new clubs will also require an increase in net working capital of $1,400,000 that will be returned at the end of the project. The tax rate is 40 percent, and the cost of capital is 10 percent.

What is the sensitivity of the NPV to each of these variables? That is, find ΔNPV/ΔP and ΔNPV/ΔQ.

43. In an effort to capture the large jet market, Airbus invested $13 billion developing its A380, which is capable of carrying 800 passengers. The plane has a list price of $280 million. In discussing the plane, Airbus stated that the company would break even when 249 A380s were sold.

(a) Assuming the break-even sales figure given is the cash flow break-even, what is the cash flow per plane?

(b) Airbus promised its shareholders a 20 percent rate of return on the investment. If sales of the

plane continue in perpetuity, how many planes must the company sell per year to deliver on this promise?

Airbus sell per year to deliver the same rate of return?

NR 439 Week 3 Research Database Assignment Form

Sunday 23 September 2018

HADM 2250 Prelim Review Questions

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