You are considering two mutually exclusive projects with the following cash flow
ID: 2623702 • Letter: Y
Question
You are considering two mutually exclusive projects with the following cash flows. Which project (s) should you accept if the discount rate is 7%? What if the discount rate is 10%?
Year 0 Project A -$275,000 Project B - $202,000
Year 1 Project A 0 Project B 113,600
Year 2 Project A 0 Project B 81,900
Year 3 Project A 360,000 Project B 47,000
2. Radiology Associated is considering an investment which will cost $ 259,000. The investment produces no cash flows for the first year. In the second year, the cash inflow is $58,000. This inflow will increase to $150,000 and then $200,000 for the following two years before ceasing permanently. The firm requires a 14% rate of return and has a required discounted payback period of three years. Accept or reject this project? Why?
3. A proposed project lasts 3 years and has an initial investment of $500,000. The after tax cash flows are estimated at $120,000 for year 1, $240,000 for year 2,and $240,000 for year 3.. The firm has a target debt/equity ratio of 0.6. The firm's cost of equity is 15% and its cost of debt is 8%. The tax rate is 35%.What is the NPV of this project? ( hint: remember that the D/E is saying that debt is 60% of equity. In other words, you need to find D/A and E/A for the appropriate weights using the formulas: D/E(1+D/E=% or weight of debt and 1/(1+D/E)=% or weight of equity.)
4. Puppy Inc. Has the following mutually exclusive investment opportunities. If the appropriate discount rate was 15% what should you do?
Year 0 Project X -500 Project Y -800
Year 1 Project X 100 Project Y 500
Year 2 Project X 475 Project Y 350
Year 3 Project X 50 Project Y 350
A. Calculate each projects payback period cutoff. Which would you accept if Puppy's payback period cutoff is 2 years?
B. Calculate each project's discounted payback period cutoff. Which would you accept if puppy's payback period cutoff is 2 years.?
C. What is the NPV for each project?
Explanation / Answer
1.
if the discount rate is 7%
NPV of Project A = -275,000+ 360,000/1.07^3 = 18,867.24
NPV of Project B = - $202,000+ 113,600/1.07^1 + 81,900/1.07^2 + 47,000/1.07^3 = $14,068.86
Accept Project A if the discount rate is 7%
What if the discount rate is 10%?
NPV of Project A = -275,000+ 360,000/1.1^3 = -4526.67
NPV of Project B = - $202,000+ 113,600/1.1^1 + 81,900/1.1^2 + 47,000/1.1^3 = $4270.473
Accept Project B if the discount rate is 10%
2.
0
1
2
3
4
5
Cash flow
-259000
0
58,000
150,000
200,000
200,000
Present value
-259000
0
44629.117
101245.727
118416.055
103873.733
discounted payback period = 2+ (259000-44629.117-101245.727)/ 118416.055= 2.96 years
Accept the project as discounted payback period is less than 3 years
3. A proposed project lasts 3 years and has an initial investment of $500,000. The after tax cash flows are estimated at $120,000 for year 1, $240,000 for year 2,and $240,000 for year 3.. The firm has a target debt/equity ratio of 0.6. The firm's cost of equity is 15% and its cost of debt is 8%. The tax rate is 35%.What is the NPV of this project? ( hint: remember that the D/E is saying that debt is 60% of equity. In other words, you need to find D/A and E/A for the appropriate weights using the formulas: D/E(1+D/E=% or weight of debt and 1/(1+D/E)=% or weight of equity.)
weight of debt = 0.6/(1.6) = 37.50%
weight of equity= 1/1.6= 62.5%
WACC = 37.5%*8%*(1-35%) + 62.5%*15%=11.325%
NPV = -500,000 + 120,000/(1+11.325%) +240,000/(1+11.325%)^2 + 240,000/(1+11.325%)^3= - 24,600.30
4.
A. Calculate each projects payback period cutoff. Which would you accept if Puppy's payback period cutoff is 2 years?
projects payback period for X = 1+(500-100)/475= 1.84 years
projects payback period for Y = 1+(800-500)/350= 1.86 years
Accept Project X
B. Calculate each project's discounted payback period cutoff. Which would you accept if puppy's payback period cutoff is 2 years.?
Present value of cash flow Project X = 100/1.15 + 475/1.15^2 + 50/1.15^3= 479
discounted payback period for Project X =0
discounted payback period for Project Y = 2+ (800-500/1.15 - 350/1.15^2)/ 350/1.15^3= 2.19 years
Reject Both
C. What is the NPV for each project?
NPV of Project X = -500 + 100/1.15 + 475/1.15^2 + 50/1.15^3= -21.00
NPV of Project Y = -800 + 500/1.15 + 350/1.15^2 + 350/1.15^3= $129.56
Accept Project Y
0
1
2
3
4
5
Cash flow
-259000
0
58,000
150,000
200,000
200,000
Present value
-259000
0
44629.117
101245.727
118416.055
103873.733
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.