Calculating Payback. Global Toys Inc., imposes a payback cutoff of three years f
ID: 2653953 • Letter: C
Question
Calculating Payback. Global Toys Inc., imposes a payback cutoff of three years for its international investment projects. If the company has the following two projects available, should it accept either of them?
Which Project should be accepted A or B?
a. The payback for Project A is: Payback =
b. The payback for Project B is: Payback =
c. Which project should be accepted:
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Calculating AAR. You’re trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $14 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $1,253,000, $1,935,000, $1,738,000, and $1,310,000 over these four years, what is the project’s average accounting return (AAR)?
Calculating AAR, the average net income divided by the average book value. (Show work by calculating net income and average book value):
a. Average net income =
b. Average book value =
c. AAR =
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Calculating IRR. A firm evaluates all of its projects by applying the IRR rule. If the required return is 11 percent, should the firm accept the following project?
Calculating IRR the interest rate that makes the NPV of the project equal to zero. (Show work by calculating IRR):
a. IRR =
b. Should the project be accepted and why?
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Calculating NPV. For the cash flows in the previous problem, suppose the firm uses the NPV decision rule. At a required return of 9 percent, should the firm accept this project? What if the required return was 21 percent?
Calculating NPV. Hint the NPV of a project is the PV of the outflows minus by the PV of the inflows. (Show work by calculating NPV):
a. @ 9% required return.
NPV@ 9% required return =
b. Should the project be accepted:
c. @ 21% required return.
NPV@ 21% required return =
d. Should the project be accepted:
Year Cash Flow (A) Cash Flow (B)0 $55,000 $ 95,000
1 19,000 18,000
2 27,000 26,000
3 24,000 28,000
4 9,000 260,000
Explanation / Answer
a) Payback for Project A is 2.38 Yrs
Payback for Project B is 3.09 Yrs
Project A should be accepted as it recovers the investment faster and also fulfills the 3 Yrs payback cut-off criteria.
b) Average Book Value = Opening Value + Closing Value/2
= 14000000/2 = 7000000
Average Net Income = Net Income(Year 1)+ Net Income(Year 2)+ Net Income(Year 3)+ Net Income(Year)/4/4
= 1253000+ 1935000+ 1738000+ 1310000/4 = 1559000
AAR = Average Net Income/ Average Book Value
= 1559000/ 7000000 = 22.27%
c) IRR = 14%
The project should be accepted because the required rate of return is 11% whereas the firm’s IRR is 14% which is 3% more than the required rate of return.
d) At a rate of return of 9%
Year
PV of Cash Flow
1
71559.63
2
56392.56
3
37836.99
Total
165789.18
NPV = 165789.18 - 153000
= 12789.18
The project should be accepted as it has a positive NPV.
At a rate of return of 21 %
Year
PV of Cash Flow
1
64462.81
2
45761.90
3
27659.22
Total
137883.93
NPV= 137883.93 – 153000
= -15116.07
The project should not be accepted as it has a negative NPV
Year
PV of Cash Flow
1
71559.63
2
56392.56
3
37836.99
Total
165789.18
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