Demonstrate your understanding of financial concepts by completing the following
ID: 2736411 • Letter: D
Question
Demonstrate your understanding of financial concepts by completing the following problems. Where appropriate, show or explain your work.
Problem 1. Calculating Payback Period and NPV: Porter, Incorporated has two exclusive projects, listed in the table below. Use the NPV rule to rank these two projects. If the appropriate discount rate is 13 percent, which project should be chosen?
Year
Project A
Project B
0
-$12,700.
-$9,400.
1
$7,000.
$4,800.
2
$5,500.
$3,750.
3
$2,500.
$3,400.
Problem 2. Calculating Payback: An investment project provides cash inflows of $920 per year for eight years. Calculate the project's payback period if the initial cost is each of the following:
•$4,500.
•$5,500.
•$7,000.
Problem 3. Calculating IRR for Cash Flows: Calculate the internal rate of return for the cash flows of the two projects in the table below.
Year
Cash Flows ($)
Project A
Project B
0
-$4,600.
-$3,500.
1
$1,400.
$1,250.
2
$2,200.
$1,800.
3
$2,700.
$1,600.
Problem 4. Calculating Profitability Index of a Project: Jeff plans to open a small health club. The equipment will cost $225,000. Jeff expects that there will be after-tax cash inflows of $62,000 annually for seven years. The equipment will then be scrapped and the health club will close. At year-end of the first year, the first cash inflow occurs. The required return is 13 percent. What is the project's profitability index? Should it be accepted?
Problem 5. Calculating Project NPV: Jenny's Creamery is considering the purchase of a $27,000 ice cream maker. The ice cream maker has an economic life of 8 years. Using the straight-line method, it will be fully depreciated. The machine will produce 250,000 servings per year, with each costing $1.25 to make, and priced at $1.99. The discount rate is 12 percent. The tax rate is 35 percent. Should the company make the purchase?
Year
Project A
Project B
0
-$12,700.
-$9,400.
1
$7,000.
$4,800.
2
$5,500.
$3,750.
3
$2,500.
$3,400.
Explanation / Answer
Answer (1).
Computation of NPV
Project A
Project B
Year
PVF@13%
Cash flow($)
Present Value($)
Cash flow($)
Present Value($)
0
1
-12700
-12700
-9400
-9400
1
0.885
7000
6195
4800
4248
2
0.783
5500
4306.50
3750
2936.25
3
0.693
2500
1732.50
3400
2356.20
Net Present Value
-466
140.45
NPV under project B is higher.
Select Project B.
Computation of Payback Period
Project A
Project B
Year
Inflows
Cumulative Inflows
Inflows
Cumulative Inflows
1
7000
7000
4800
4800
2
5500
12500
3750
8550
3
2500
15000
3400
11950
Payback Period
For Project A = 2 year+ (12700-12500)/2500
=2.08 Year
For Project B = 2 year + (9400-8550)/3400
=2.25 Year
Project A
Project B
Year
PVF@13%
Cash flow($)
Present Value($)
Cash flow($)
Present Value($)
0
1
-12700
-12700
-9400
-9400
1
0.885
7000
6195
4800
4248
2
0.783
5500
4306.50
3750
2936.25
3
0.693
2500
1732.50
3400
2356.20
Net Present Value
-466
140.45
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