Capital Investments quiz

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

CFO = -100; CF1 = 40 ; CF2 = 80 ; CF3 = 120 ; I = 20 ; CPT → NPV = $ 58.33

or

Cash flows are based on opportunity costs. Financing costs are recognized in the project’s required rate of return. Accounting net income, which includes non-cash expenses, is irrelevant; incremental cash flows are essential for making correct capital allocation decisions .

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

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 . 

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

or

Expansion projects increase the scale of a firm’s existing activities and/or extend a firm’s reach into new product or service categories and markets, in the hopes of generating longer-term expected gains. Regulatory/compliance projects are required for the business to continue operations but otherwise might not be undertaken by a company. Going concern projects benefit the company through improved efficiencies and cost savings over time .

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

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.

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 .

The IRR is the discount rate that makes the NPV = 0. Because the cash flow stream is in perpetuity, it can be solved as follows:

0 = –270 + (30/IRR)

IRR = 11.1%

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.

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

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 .

Stock prices reflect investor expectations for future investment and growth. A new positive-NPV project will increase stock price only if it was not previously anticipated by investors .

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 .

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 .

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.

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.

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 .

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 .

If demand is “high,” the NPV is as follows:

CF0 = – 190 ; CF1 = 40 ; F1 = 10;  I = 10 ; CPT NPV = 55.78

If demand is “low,” the NPV is

CF0 = – 190 ; CF1 = 20 ; F1 = 10;  I = 10 ; CPT NPV = - 67.11

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. 

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.

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.

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.

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

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 .