FINA 365 Lecture Notes - Lecture 7: Net Present Value, Savings Account, Opportunity Cost

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ambermuskrat630

6 Mar 2017

School

USC, SC, Carolina, South Carolina

Department

Finance

Course

FINA 365

Professor

Robert Hartwig

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Document Summary

Invest 500$ today, will receive 550$ in one year at 8% a year. As long as npv is positive, the decision increases the value of the firm. You have saved 1500$ and are about to buy a tv. You take it home today and will owe 1500 a year from now. Savings account earns 5%, what is the npv. Company needs a new factory that will be built at a cost or 81. 6 million. Return will be 28 million after first year and will last for four years. High cost of capital means the project will be more risky. Irr is the rate of return that sets npv = to 0. Based on notion that an opportunity that pays back initial investment quickly is a good idea. Reject the project is payback period is greater than pre-specified length of time. Ignores time value of money, ignores cash flows after payback period, not grounded in economics.

Related Questions

Which of the following may be responsible for a fair share of the perennial "project cost overruns"?

Rapidly rising inflation

Delays in obtaining contracts and permits

Lack of raw materials

Forecasting bias by the sponsoring manager

A firm with 50% of sales going to variable costs, $1.6 million fixed costs, and $510,000 depreciation would show what accounting profit with sales of $4 million? Ignore taxes.

rev: 07_27_2012

$800,000 loss

Zero loss

$110,000 loss

$400,000 loss

A firm with $780,000 fixed costs and $380,000 depreciation is expected to produce $405,000 in profits. What is its DOL? (Do not round intermediate calculations.)

3.86

2.93

3.93

2.86

When the level of fixed costs is decreased, the break-even level of revenues:

will automatically decrease.

will automatically increase.

may or may not be changed, depending on variable costs.

will remain unchanged, because fixed costs cannot be altered.

If a decision tree indicates an expected NPV of $1 million, then:

at least one of the outcomes had a negative NPV.

all of the outcomes had a positive NPV.

$1 million is the firm's minimum guaranteed profit.

the project still contains uncertainty.

If forecasted sales exceed the break-even level but are less than the economic break-even level, the project has a:

positive NPV but earns less than the discount rate.

negative NPV but earns more than the discount rate.

net loss on the income statement.

net profit on the income statement.

What is the accounting break-even level of revenues for a firm with $9 million in sales, variable costs of $5.4 million, fixed costs of $1.4 million, and depreciation of $1 million? (Do not round intermediate calculations.)

$7,500,000

$6,000,000

$7,800,000

$3,500,000

What happens to the NPV of a one-year project if fixed costs are increased from $550 to $900, the firm is profitable, has a 40% tax rate, and employs a 11% cost of capital?

NPV decreases by $210.00.

NPV decreases by $189.19.

NPV decreases by $350.00.

NPV decreases by $315.32.

Calculate the ratio of variable costs to sales for a firm with $3,900,000 accounting break-even revenues, $1.6 million fixed costs, and $740,000 depreciation.

60%

41%

40%

59%

ivorykoala123

You can invest in a risk-free technology that requires an upfront payment of $1.18 million and will provide a perpetual annual cash flow of $77,000. Suppose all interest rates will be either 9.9 % or 4.7% in one year and remain there forever. The risk-neutral probability that interest rates will drop to 4.7% is 95%. The one-year risk-free interest rate is 8.4%, and today's rate on a risk-free perpetual bond is 5.3%. The rate on an equivalent perpetual bond that is repayable at any time (the callable annuity rate) is 9.4%.

a. What is the NPV of investing today?

b. What is the NPV of waiting and investing tomorrow?

c. Verify that the hurdle rate rule of thumb gives the correct time to invest in this case.

a. What is the NPV of investing today?

The NPV is $__________. (Round to the nearest dollar.)

b. What is the NPV of waiting and investing tomorrow?

The NPV if the rate goes up is $____________. (Round to the nearest dollar.)

The NPV if the rate goes down is $_________. (Round to the nearest dollar.)

The PV is $__________. (Round to the nearest dollar.)

c. Verify that the hurdle rate rule of thumb gives the correct time to invest in this case.

The hurdle rule is $___________. (Round to the nearest dollar.)

The NPV < 0, so (1) invest now or (2) wait. (Select one of them)

browneel731

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?

Year Cash Flow (A) Cash Flow (B)
0 â$55,000 â$ 95,000
1 19,000 18,000
2 27,000 26,000
3 24,000 28,000
4 9,000 260,000

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:

____________________________________
Calculating AAR. Youâre 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 projectâs 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 =

_________________________________________

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?

Year Cash Flow
0 â$153,000
1 78,000
2 67,000
3 49,000

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?

________________________________

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:

orangecricket262

FINA 365 Lecture Notes - Lecture 7: Net Present Value, Savings Account, Opportunity Cost

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