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FIN 401 Study Guide - Final Guide: Net Present Value, Kentucky Educational Television, Neuropeptide Y

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School
Ryerson University
Department
Finance
Course
FIN 401
Professor
Melissa Toffanin

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Document Summary

Method #1: npv difference between the market value of a project and its cost. If the npv is positive, accept the project. A positive npv means that the project is expected to add value to the firm and will increase the wealth of the owners. 180,000/(1. 15)^3 = ,542 > 0 (we would accept this) Calculator: enter -200,000 in cell 1 & and rest of the #"s following that, press f1 for npv, i%=15% press f5. Method #2: payback period assume we accept project if pays back in 2 years. Calculator: enter cf"s as before, use i%= 0%, press f3 for payback = 2. 416 *we wouldn"t accept this project* Discounted pbp: accept project if it pays back on discounted basis. Method #3: internal rate of return (irr) irr is the return that makes npv=0. Accept project if the irr is greater than required return (i%). If irr is less than i%, but the npv>0, we accept the project.

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Related Questions

Aluminum Building Products Company (ABPC) is considering investing in either of the two mutually exclusive projects described as follows:

Project 1. Buying a new set of roll-forming tools for its existing roll forming line to introduce a new cladding product. After its introduction, the product will need to be promoted. This means that cash inflows from additional production will start sometime after and will gradually pick up in subsequent periods.

Project 2. Modifying its existing roll-forming line to increase productivity of its available range of cladding products. Cash inflows from additional production will start immediately and will reduce over time as the products move through their life cycle. Sarah Brown, project manager of ABPC, has requested that you do the necessary financial analysis and give your opinion about which project ABPC should select.

The projects have the following net cash flow estimates:

Year project 1 project 2

0 (200,000) (200,000)

1 0 90,000

2 0 70,000

3 20,000 50,000

4 30,000 30,000

5 40,000 10,000

6 60,000 10,000

7 90,000 10,000

8 100,000 10,000

Both these projects have the same economic life of eight years and average risk characteristics. ABPC’s weighted average cost of capital, or hurdle rate, is 7.2 percent.

a ) Which project would you recommend Ms. Brown accept to maximize value of the firm? (Hint: Calculate and compare NPVs of both projects.)

b) What are the IRRs of each project? Which project should be chosen using IRR as the selection criterion?

c) Draw the NPV profiles of both projects. What is the approximate discount rate at which both projects would have the same NPC? what is that NPV?

d) Does the selection remain unaffected for i) WACC> 5.4 percent; ii) WACC > 8.81 percent; and iii) WACC > 14.39 percent?

e) Further market survey research indicates that both projects have lower- than- average risk and, hence, the risk- adjusted discount rate should be 5 percent. What happens to the ranking of the projects using NPV and IRR as the selection criteria? Explain the conflict in ranking, if any.

f) Answer questions a, d, e, assuming the projects are independent of each other.

Excel

Problem: The Drillago Company is involved in searching for locations in which to drill for oil. The firm’s current project requires an initial investment of $16.5 million and has an estimated life of 9 years. The expected future cash inflows for the project are as shown in the following table. All cash flows are expected to occur at the end of the year. The cost of capital is 11%.

Year 1 2 3 4 5 6 7 8 9
Cash slow 500,000 750,000 1,000,000 3,000,000 3,500,000 4,500,000 6,000,000 8,000,000 11,000,000


Create a spreadsheet to answer the following questions. Depict time in the columns, as shown above. Year: 1 2 3 4 5 6 7 8 9 Cash Inflo w 500,00 0 750,00 0 1,000,00 0 3,000,00 0 3,500,00 0 4,500,00 0 6,000,00 0 8,000,00 0 11,000,00 0

1. Calculate the project’s NPV. Is the project acceptable under the NPV technique?

2. Calculate the project’s IRR. Is the project acceptable under the IRR technique?

3. Did the NPV and IRR produce the same accept/reject results? Is there a preference for NPV or IRR?

4. Calculate the project’s MIRR. How does it compare to the project IRR? Explain why the difference occurs.

5. Calculate the payback period for the project. If the firm usually accepts projects that have payback periods between 1 and 7 years, is this project acceptable? Note – you do not need to use an excel function for this answer. Instead, add an additional line to your spreadsheet and show the cumulative dollar return from the project for each year. From there, you can determine a rough idea of the payback period.

For example, the cumulative returns in the first few years are:

Year 1 = -$16.5m + $0.5 m = -$16.0m.

Year 2 = -$16.0m + $0.75m = -$15.25m

Question 13 Your firm has bonds outstanding with 18 years remaining until maturity. The bonds are trading for $1127 and pay a 8.5% coupon rate. Your firm faces a 32% tax rate. Based on this, the after-tax cost of debt financing is

None of the other answers are correct
7.23%
8.50%
4.92%
5.78%

Question 14 You have estimated the following values for dividends over the next four years.

D1 = $1.50

D2 = $2.50

D3 = $3.50

D4 = $4.50

In addition, you anticipate that you can sell the stock four years from today (immediately after you receive the year four dividend) for $50. Assuming a 9% required return, the value of the stock today is

$44.79
$45.64
$41.87
$49.49

Question 15 Developed equity markets have seen higher returns than emerging equity markets over the the Nov. 2004 to June 2012 time frame.

True
False

Question 16 You are evaluating a capital budgeting project that will cost $25,000

Year 1 ==> $12,000

Year 2 ==> $20,000

Year 3 ==> $9,000

The required return is 13% and the critical acceptance level is 1.9 years. Calculate the Internal Rate of Return and determine whether or not the project should be accepted based solely on the Internal Rate of Return.

The IRR is 21.33% and we should reject the project
The IRR is 17.27% and we should accept the project
The IRR is 17.27% and we should reject the project
The IRR is 21.33% and we should accept the project
None of the other answers is correct

Question 17 Linda is saving for retirement and would like to accumulate $800,000 at her retirement. She currently has $30,000 saved and would like to work for another 25 years. She plans to save $3500 at the end of each year over the next 25 years. What rate of return must she earn on her investments over the next 25 years?

10.95%
12.45%
8.76%
7.23%
9.42%

Question 18 Consider two projects:

Project A Project B

PP 2.8 years 3.0 years

IRR 12.5% 13.3%

NPV -$15,500 -$16,900

Assume that the projects both have a required return of 15% and a critical acceptance level (T) of 3.25 years. If these are independent projects we should

Take both projects A and B
Take project B and reject project A
Take neither project
Take project A and reject project B

Question 20 Your firm wants to raise $4924796 by issuing preferred stock. The stock has a par value of $50 and pays a 6% dividend, how many shares must be issued if the required return is 10% (ignore costs associated with issuing the shares known as floatation costs -- round to the nearest share)?