Core Principles and Applications CHAPTER 7: PROBLEM 1b Project A Project B Disco

Question

Core Principles and Applications CHAPTER 7: PROBLEM 1b

Project A

Project B

Discount Rate

15%

15%

Year 0

($14,500)

($9,800)

Year 1

$8,500

$4,700

Year 2

$6,800

$4,200

Year 3

$2,800

$4,100

NPV =

(Note: You will choose the project that has the highest NPV since it creates the most wealth.)

Project A

Project B

Discount Rate

15%

15%

Year 0

($14,500)

($9,800)

Year 1

$8,500

$4,700

Year 2

$6,800

$4,200

Year 3

$2,800

$4,100

NPV =

(Note: You will choose the project that has the highest NPV since it creates the most wealth.)

Explanation / Answer

15%

15%

Project A Project B Discount Rate

15%

15%

Year 0 ($14,500) ($9,800) Year 1 $8,500 $4,700 Year 2 $6,800 $4,200 Year 3 $2,800 $4,100 NPV of Project A = -$14500 +($8500/1.15^1)+($6800/1.15^2)+($2800/1.15^3) = $            (1,372.45) NPV of Project B = -$9800+($4700/1.15^1)+($4200/1.15^2)+($4100/1.15^3) = $                (499.78) Problem 2 Year A B C 0 $3,200 $4,600 $7,900 1 825 825 825 2 825 825 825 3 825 825 825 4 825 825 825 5 825 825 825 6 825 825 825 7 825 825 825 8 825 825 825 Payback $3200/$825 $4600/$825 $7900/$825 Period $3.88 $5.58 $9.58 Problem 8 Year Project A Project B 0 ($5,200) ($3,600) 1 1800 1300 2 3200 2100 3 2200 1800 IRR = NPV =0 Pv of Future Cash Flows- Initial Inflows =0 1800/1+r^1+3200/1+r^2+2200/1+r^3-5200 =0 Assume r =10% Then 1800/1.1+3200/1.1^2+2200/1.1^3-5200 733.8843 Assume r =15% 1800/1.15+3200/1.15^2+2200/1.15^3-5200 231.412838 Assume r =17% 1800/1.17+3200/1.17^2+2200/1.17^3-5200 49.7201259 As the r = 17% is close to zero the IRR of Project A is 17% Assume r =10% Then 1300/1.1+2100/1.1^2+1800/1.1^3-3600 669.7220135 Assume r =15% 1300/1.15+2100/1.15^2+1800/1.15^3-3600 301.8657023 Assume r =17% 1300/1.17+2100/1.17^2+1800/1.17^3-3600 169.0565698 Assume r =19% 1300/1.19+2100/1.19^2+1800/1.19^3-3600 43.53155993 As the r = 19% is close to zero the IRR of Project B is 19% Problem 9 NPV         = 62000/1.15^1+62000/1.15^2+62000/1.15^3+62000/1.15^4+62000/1.15^5+62000/1.15^6+62000/1.15^7 NPV         = 238266.64 Profitability Index = Present Value of Future Inflows/Initial Investment = $238266.64/$185000 = 1.29

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