Capital Investments quiz

Sunk costs should be excluded from cash flows, as they are costs that cannot be avoided even if the project is not undertaken. Externalities, such as positive or negative effects of accepting a project on sales of the company's existing products, should be included in the cash flows.

The IRR is computed by identifying all cash flows and solving for the rate that makes the NPV of those cash flows equal to zero.

Calculate the PV of the project cash flows

N = 5, PMT = -3,000, FV = 0, I/Y = 9.7, CPT → PV = 11,460

Calculate the project NPV by subtracting out the initial cash flow

NPV = $11,460 – $10,000 = $1,460

or

CF0 = –$10,000 ; CF1 = $3,000 ; F1 = 5 ; I= 9.7  CPT → NPV = $1,460

or

CF0 = –$10,000

CF1 = $3,000 

CF2 = $3,000

CF3 = $3,000 

CF4 = $3,000 

CF5 = $3,000 

 I= 9.7

 CPT → NPV = $1,460

Sunk costs are not to be included in investment analysis. Opportunity costs and the project's impact on taxes are relevant variables in determining project cash flow for a capital investment.

Because all Bearing’s projects have a positive NPV, they are all providing a return that is greater than the opportunity COC. Therefore, the ROIC must be greater than the COC .

Rescheduling and prioritizing projects is part of the planning stage of the capital budgeting process, not the post-audit. The post-audit’s purpose is to explain any differences between the actual and predicted results of a capital budgeting project. This process can aid in indicating systematic errors, improve business operations, and provide concrete ideas for future investment opportunities.

The NPV of the new equipment is $700 million - $400 million = $300 million.

The NPV of this project is added to Fullen’s current market value.

On a per share basis, the addition is worth $300 million / 200 million shares, for a net addition to the share price of $1.50.  $36.00 + $1.50 = $37.50.

CF0 = –$550,000 ;  CF1 = $65,000 ; F1 = 5;  CF2 = $50,000; F2 = 3;   CF3 = $350,000; F3 = 1 . CPT IRR = 7.0152.

Note that the cash flows in year 9 have to be netted to calculate the IRR correctly.

CFO = -2,2; CF1 = 1,3; CF2 = 1,6 ; CF3 = 1,9; CF4 = 0,8 ;  I = 8 ; CPT → NPV = $2,47

or

he study is a sunk cost, and the possible increase in sales of a related product is an example of a positive externality.

Project X

CF0 = – 15,000 ; CF1 = 2,000 ;  CF2 = 5,000 ; CF3 = 8,000 ; CF4 = 8,000 ; I = 15 ; CPT NPV = 354.0046

IRR= 16 % (given)

Project Y

CF0 = – 13,250 ; CF1 = 200 ;  CF2 = 500 ; CF3 = 7,000 ; CF4 = 15,000 ; I = 15 ; CPT NPV = 480.8972

CF0 = – 13,250 ; CF1 = 200 ;  CF2 = 500 ; CF3 = 7,000 ; CF4 = 15,000 ;  CPT IRR = 16.1542

Because these projects are mutually exclusive, only one can be undertaken: It should be Project Y, which has the highest NPV and thus increases shareholder wealth the most. Both projects’ IRRs exceed the hurdle rate, and the IRR of Project Y exceeds that of Project X. The decision, however, should be based on the superior NPV of Project Y

(Both projects ) is incorrect. Both NPV_X and NPV_Y are positive, but because they are mutually exclusive projects, only the one with higher positive NPV will be chosen

Based on the IRRs, the move to South Carolina will have a positive NPV (the IRR is greater than the discount rate) and the move to Texas will have a negative NPV. In this case, we can rank the two projects based on their IRRs. If the appropriate discount rate was less than both IRRs, for example, 10%, the IRR rankings could not reliably be used to choose between the two proposed moves .

Financing costs are reflected in a project's required rate of return. Project specific financing costs should not be included as project cash flows. The firm's overall weighted average cost of capital, adjusted for project risk, should be used to discount expected project cash flows.

CFO = -100,000;  CF1 = 10,000;  CF2 = 15,000;  CF3 = 138,000;  I = 12; CPT → NPV = $19,112.

The key is first identifying this as a NPV problem. The minimum price the company should accept for selling the property is the net present value of the mine if the company built and operated it.

Next, the year of each cash flow must be property identified; specifically: CF0 = –430,000 ; CF1-7 = +$200,000 ; CF8 = –$170,000.

Entering these values into the cash flow worksheet:

CF0 = –430,000 ; C01 = 200,000; F01 = 7 ; C02 = –170,000 ; F02 = 1 ; I = 16 ; CPT NPV = 325,858.76

Using a financial calculator :

CF0 = – 750 ; CF1 = 175 ; F1 = 7; CPT IRR = 14.0198

CF0 = – 750 ; CF1 = 175 ; F1 = 7;  I = 10 ; CPT NPV = 101.9733

The option to abandon the project and receive the market value of the facility if actual cash flows are less than expected over the first two years can be viewed as a valuable put option that should be included in the calculation of the project’s NPV. 

For these investments, a discount rate of 13.16% would yield the same NPV for both (an NPV of 6.73).

We subtract the two investments from each other:

CF0 = – 100 - (– 100)  = 0

CF1 = 36 - 0 = 36   ; F1 = 3

CF2 = 36 - 175 = - 139   ; F1 = 1

CPT IRR = 13.159

CF0 = – 100 - (– 100)  = 0

CF1 = 36 - 0 = 36   ; F1 = 3

CF2 = 36 - 175 = - 139   ; F1 = 1

I= 13.159

CPT NPV = 6.7282

There are many factors that can affect the stock price, including whether Ms. Ndereba’s analysis indicates that the project is more or less profitable than investors expected .

In theory, a positive NPV project should provide an increase in the value of a firm's shares.

NPV of new capital equipment = $50 million - $30 million = $20 million

Value of company prior to equipment purchase = 8,000,000 × $28.00 = $224,000,000

Value of company after new equipment project = $224 million + $20 million = $244 million

Price per share after new equipment project = $244 million / 8 million = $30.50

Note that in reality, changes in stock prices result from changes in expectations more than changes in NPV.

The NPV rule’s assumption about reinvestment rates is more realistic and more economically relevant than the IRR rule because it incorporates the market-determined opportunity cost of capital as a discount rate. In contrast, the IRR calculation assumes reinvestment at the IRR, which sometimes cannot be achieved because it is too high. Time-weighted rate of return suffers similar shortcomings as IRR.

Going concern projects are those to maintain the business or to increase the efficiency of existing operations. The other two projects are business growth investments that increase the size of the company .

Using a financial calculator or the trial and error method, the IRR is 28.79%. The COC, which is stated as 10%, is not used to solve the problem.

Using a financial calculator:

Cf0 = -150,000 ;C01 = 100,000 ; C02 = 120,000 ; CPT IRR = 28.7855

Project P ⇒ N = 5; PMT = 5,000; FV = 0; I/Y = 12; CPT → PV = 18,024;  NPV for Project A = 18,024 – 15,000 = 3,024.
Project Q ⇒ N = 5; PMT = 7,500; FV = 0; I/Y = 12; CPT → PV = 27,036;  NPV for Project B = 27,036 – 25,000 = 2,036.

For independent projects the NPV decision rule is to accept all projects with a positive NPV. Therefore, accept both projects.

or

Project P  ⇒ Cf0 = -15,000, C01 = 5,000, F01 = 5,  I = 12 ;  CPT NPV = 3,024.

Project Q  ⇒ Cf0 = -25,000, C01 = 7,500, F01 = 5,  I = 12 ;  CPT NPV = 2,036.

Mutually exclusive means that out of the set of possible projects, only one project can be selected. Given two mutually exclusive projects, the company can accept one of the projects or reject both projects, but cannot accept both projects .

It is quite possible that offering a matching dryer will increase sales of their washers, because some consumers will prefer a matching set. The increased sales of their washers is a positive externality, and those incremental sales should be considered in the analysis. Cannibalization would be a consideration if the introduction of dryers was expected to decrease washer sales. Sunk costs should not be considered in project analysis .

A post-audit identifies what went right and what went wrong. It is used to improve forecasting and operations .

NPV for Project X ⇒ CF0 = – 100,000 ; C01 = 50,000; C02 = 40,000; C03 = 30,000; C04 = 10,000; I = 15; CPT NPV = -833

NPV for Project Z ⇒ CF0 = – 100,000 ; C01 = 10,000; C02 = 30,000; C03 = 40,000; C04 = 60,000; I = 15; CPT NPV = - 8,014

Reject both projects because neither has a positive NPV.

he given cash flows are inserted into a financial calculator along with the 10% discount rate:

CF₀ = −1,500, CF₁ = 300, CF₂ = 600, CF₃ = 1,000, CF₄ = 200, CF₅ = 500, CF₆ = 300, I = 10. Computing NPV the result is 636.32 ~ 636 .

Mandatory regulatory or environmental projects may be required by a governmental agency or insurance company and typically involve safety-related or environmental concerns. The projects typically generate little to no revenue, but they accompany other new revenue producing projects and are accepted by the company in order to continue operating .