Capital Investments quiz

Since the sale was not anticipated by the market, the share price should rise by the NPV of the project per common share. NPV is already calculated using after-tax cash flows.

The IRR would stay the same because both the initial outlay and the after-tax cash flows double, so the return on each dollar invested would remain the same. All the cash flows and their present values double. The difference between the total present value of the future cash flows and the initial outlay (the NPV) also doubles .

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 .

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

In valuing investments, expected cash flows should be discounted at required rates of return that reflect their risk, not at a risk-free rate that ignores risk. NPV is superior to IRR. Choosing projects based on IRR might cause the company to concentrate on short-term investments that do not maximize the company’s NPV . 

CF0 = –5,000 ; CF1 = 3,000 ; CF2 = 2,000 ; CF3 = 2,000 ; I / Y = 10 ; NPV = $883 

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

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

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.

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.

Costs to finance the investment are taken into account when the cash flows are discounted at the appropriate COC; including interest costs in the cash flows would result in double-counting the cost of debt .

The cost of the marketing survey should not be included because it is a sunk cost; it will be incurred whether they decide to do the project or not. The decrease in sales of their current sauce if the spicier version is introduced (cannibalization) should be considered in the analysis. The cost of recipe development should be included because it will only be incurred if they decide to go ahead with the introduction of the new spicier sauce .

Externalities refer to the effects that the acceptance of a project may have on other firm cash flows. Cannibalization is one example of an externality.

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.

Cf0 = -775,000 , C01 = 0, F01 = 1,  C02 = 300,000, F02 = 2,  C03 = 400,000, F03 = 1;  IRR = 8.6534

or

Cf0 = -775,000 , C01 = 0,  C02 = 300,000,  C03 = 300,000, C04 = 400,000 ;  IRR = 8.6534

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.

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.

Discount rates of 0% and approximately 61.8% both give an NPV of zero

CF0 = – 50 ; CF1 = 100 ;  CF2 = 0 ; CF3 = - 50 ; I = 0 ; CPT NPV = 0

CF0 = – 50 ; CF1 = 100 ;  CF2 = 0 ; CF3 = - 50 ; I = 32 ; CPT NPV = 4.0181

CF0 = – 50 ; CF1 = 100 ;  CF2 = 0 ; CF3 = - 50 ; I = 62 ; CPT NPV = - 0.0321

When the NPV = 0, this means the discount rate used is equal to the IRR. If a discount rate is used that is higher than the IRR, the NPV will be negative. Conversely, if a discount rate is used that is lower than the IRR, the NPV will be positive

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 .

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 .

The NPV sums the investment’s expected cash flows (CF) discounted at the opportunity COC. The NPV calculation is 

where

CFt = the expected net cash flow at time t

N = the investment’s projected life

r = the discount rate or opportunity COC

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

The projects are independent, meaning that either one or both projects may be chosen. Both projects have positive NPVs, therefore both projects add to shareholder wealth and both projects should be accepted.

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 .

The project should be accepted on the basis of its positive NPV and its IRR, which exceeds the cost of capital.

Arranging financing is not one of the administrative steps in the capital budgeting process. The four administrative steps in the capital budgeting process are:

1. Idea generation

2. Analyzing project proposals

3. Creating the firm-wide capital budget

4. Monitoring decisions and conducting a post-audit

CF0 = – $336,875

CF1 = $100,000

CF2 = $ 82,000

CF3 = $ 76,000

CF4 = $ 111,000

CF5 = $ 142,000

 I= 8

 CPT → NPV =  $64,582

or

To determine the net present value of the investment, given the required rate of return, we can discount each cash flow to its present value, sum the present value, and subtract the required investment.

Using either the IRR function in Excel or a financial calculator

CFO = -50,000; CF1 = 15,000; CF2 = 15,000; CF3 = 20,000; CF4 = 10,000 ; CF5 = 5,000  I = 8; CPT → NPV = $3,378.83

CFO = -50,000; CF1 = 15,000; CF2 = 15,000; CF3 = 20,000; CF4 = 10,000 ; CF5 = 5,000   CPT → IRR = 10.8795 

or

NPV = -50, 000 + 13, 888.89 + 12, 860.08 + 15, 876.64 + 7, 350.30 + 3, 402.92

NPV = -50, 000 + 53, 378.83 = 3, 378.83

Introducing a new product or entering a new market involves sales and expense projections that can be highly uncertain, and therefore require the greatest degree of detailed analysis. Addressing safety or regulatory concerns or replacing old machinery typically involve less uncertainty and do not require the same depth of analysis as developing a new product or entering a new market .