Grand Canyon FIn450 module 1 and 2 assignemnt

P10-25

*All techniques with NPV profile: Mutually exclusive projects *Projects A
and B, of

equal risk, are alternatives for expanding Rosa Company’s capacity. The
firm’s cost

of capital is 13%. The cash flows for each project are shown in the
following table.

*a. *Calculate each project’s *payback period*.

*b. *Calculate the *net present value (NPV) *for each project.

*c. *Calculate the *internal rate of return (IRR) *for each project.

*d. *Draw the *net present value profiles *for both projects on the same
set of axes, and

discuss any conflict in ranking that may exist between NPV and IRR.

*e. *Summarize the preferences dictated by each measure, and indicate which
project

you would recommend. Explain why.

* Project A
 Project B*

*Initial investment (**CF**0**) $80,000 $50,000*

*Year (**t**) Cash inflows (**CF**t**)*

1 $15,000 $15,000

2 20,000
 15,000

3 25,000
 15,000

4 30,000
 15,000

5 35,000
 15,000

P11-4

*Sunk costs and opportunity costs *Masters Golf Products, Inc., spent 3
years and

$1,000,000 to develop its new line of club heads to replace a line that is
becoming obsolete.

To begin manufacturing them, the company will have to invest $1,800,000 in

new equipment. The new clubs are expected to generate an increase in
operating cash

inflows of $750,000 per year for the next 10 years. The company has
determined that

the existing line could be sold to a competitor for $250,000.

*a. *How should the $1,000,000 in development costs be classified?

*b. *How should the $250,000 sale price for the existing line be classified?

*c. *Depict all the known relevant cash flows on a time line.

P11-8

*Book value and taxes on sale of assets *Troy Industries purchased a new
machine

3 years ago for $80,000. It is being depreciated under MACRS with a 5-year
recovery

period using the percentages given in Table 4.2 on page 000. Assume a 40%
tax rate.

*a. *What is the *book value *of the machine?

*b. *Calculate the firm’s tax liability if it sold the machine for each of
the following

amounts: $100,000; $56,000; $23,200; and $15,000.

P11-17

*Incremental operating cash flows *Richard and Linda Thomson operate a
local lawn

maintenance service for commercial and residential property. They have been
using

a John Deere riding mower for the past several years and believe that it is
time to

buy a new one. They would like to know the incremental (relevant) cash flows

associated with the replacement of the old riding mower. The following data
are

available:

There are 5 years of remaining useful life on the old mower.

The old mower has a zero book value.

The new mower is expected to last 5 years.

The Thomsons will follow a 5-year MACRS recovery period for the new mower.

Depreciable value of the new mower is $1,800.

They are subject to a 40% tax rate.

The new mower is expected to be more fuel efficient, maneuverable, and
durable

than previous models and can result in reduced operating expenses of $500
per year.

The Thomsons will buy a maintenance contract that calls for annual payments

of $120.

Create an *incremental operating cash flow *statement for the replacement
of Richard

and Linda’s John Deere riding mower. Show the incremental operating cash
flow for

the next 6 years.

P11-23

*Relevant cash flows for a marketing campaign *Marcus Tube, a manufacturer
of

high-quality aluminum tubing, has maintained stable sales and profits over
the past

10 years. Although the market for aluminum tubing has been expanding by 3%
per

year, Marcus has been unsuccessful in sharing this growth. To increase its
sales, the

firm is considering an aggressive marketing campaign that centers on
regularly running

ads in all relevant trade journals and web sites and exhibiting products at
all

major regional and national trade shows. The campaign is expected to
require an

*annual *tax-deductible expenditure of $150,000 over the next 5 years.
Sales revenue,

as shown in the accompanying income statement for 2015, totaled
$20,000,000. If

the proposed marketing campaign is not initiated, sales are expected to
remain at

this level in each of the next 5 years, 2016 through 2020. With the
marketing campaign, sales are expected to rise to the levels shown in the
accompanying table

for each of the next 5 years; cost of goods sold is expected to remain at
80% of

sales; general and administrative expense (exclusive of any marketing
campaign outlays)

is expected to remain at 10% of sales; and annual depreciation expense is
expected

to remain at $500,000. Assuming a 40% tax rate, find the *relevant cash*

*flows *over the next 5 years associated with the proposed marketing
campaign.





*Marcus Tube Income Statement for*

*the Year Ended December 31, 2015*

Sales revenue $20,000,000

Less: Cost of goods sold (80%) 16,000,000

Gross profits $ 4,000,000

Less: Operating expenses

General and administrative expense (10%) $ 2,000,000

Depreciation expense 500,000

Total operating expense $ 2,500,000

Earnings before interest and taxes $ 1,500,000

Less: Taxes (rate 5 40%) 600,000

Net operating profit after taxes 900,000

*Marcus Tube Sales*

*Forecast*

*Year Sales revenue*

2016 $20,500,000

2017 21,000,000

2018 21,500,000

2019 22,500,000

2020 23,500,000

*MODULE 2*

P12-3

*Breakeven cash inflows and risk *Blair Gasses and Chemicals is a supplier
of highly

purified gases to semiconductor manufacturers. A large chip producer has
asked Blair

to build a new gas production facility close to an existing semiconductor
plant. Once

the new gas plant is in place, Blair will be the exclusive supplier for
that semiconductor

fabrication plant for the subsequent 5 years. Blair is considering one of
two plant

designs. The first is Blair’s “standard” plant, which will cost $30 million
to build. The

second is for a “custom” plant, which will cost $40 million to build. The
custom plant

will allow Blair to produce the highly specialized gases that are required
for an emerging

semiconductor manufacturing process. Blair estimates that its client will
order

$10 million of product per year if the traditional plant is constructed,
but if the customized

design is put in place, Blair expects to sell $15 million worth of product
annually

to its client. Blair has enough money to build either type of plant, and,
in the absence

of risk differences, accepts the project with the highest NPV. The cost of
capital is 12%.

*a. *Find the NPV for each project. Are the projects acceptable?

*b. *Find the *breakeven cash inflow *for each project.

*c. *The firm has estimated the probabilities of achieving various ranges
of cash inflows

for the two projects as shown in the following table. What is the
probability

that each project will achieve at least the breakeven cash inflow found in
part *b*?

*Probability of achieving*

*cash inflow in given range*

*Range of cash inflow ($ millions) Standard Plant
Custom Plant*

$0 to $5
0% 5%

$5 to $8
10 10

$8 to $11
 60 15

$11 to $14
25 25

$14 to $17 5
 20

$17 to $20 0
 15

Above $20
0 10



*d. *Which project is more risky? Which project has the potentially higher
NPV?

Discuss the risk–return trade-offs of the two projects.

*e. *If the firm wished to minimize losses (that is, NPV 6 $0), which
project would

you recommend? Which would you recommend if the goal were to achieve a

higher NPV?



P12-4

*Basic scenario analysis *Murdock Paints is in the process of evaluating
two mutually

exclusive additions to its processing capacity. The firm’s financial
analysts have developed

pessimistic, most likely, and optimistic estimates of the annual cash
inflows

associated with each project. These estimates are shown in the following
table.

* Project A
 Project B*

*Initial investment (**CF**0**) *2 -*$8,000 *
-*$8,000*

*Outcome Annual cash inflows
(**CF**)*

Pessimistic $
200 $ 900

Most likely
1,000 1,000

Optimistic 1,800
 1,100

*a. *Determine the *range *of annual cash inflows for each of the two
projects.

*b. *Assume that the firm’s cost of capital is 10% and that both projects
have 20-year

lives. Construct a table similar to this one for the NPVs for each project.
Include

the *range *of NPVs for each project.

*c. *Do parts *a *and *b *provide consistent views of the two projects?
Explain.

*d. *Which project do you recommend? Why?

P12-8

*Risk-adjusted discount rates: Basic *Country Wallpapers is considering
investing in

one of three mutually exclusive projects, E, F, and G. The firm’s cost of
capital, *r*, is

15%, and the risk-free rate, *R**F*, is 10%. The firm has gathered the
basic cash flow

and risk index data for each project as shown in the following table.

*
Project (**j**)*

*
E F G*

*Initial investment (**CF**0**) *2
*?$15,000 ?$11,000 ?$19,000*

* Year (**t**)
Cash inflows (**CF**t**)*

1
$ 6,000 $ 6,000 $ 4,000

2
6,000 4,000 6,000

3
6,000 5,000 8,000

4

6,000 2,000 12,000

Risk index (*RI**j*)
1.80 1.00 0.60

*a. *Find the *net present value (NPV) *of each project using the firm’s
cost of capital.

Which project is preferred in this situation?

*b. *The firm uses the following equation to determine the risk-adjusted
discount

rate, RADR*j*, for each project *j*:

*RADR**j *= *R**F *+ 3*RI**j ** (*r *- *R**F*) 4

where

*R**F *= risk@free rate of return

*RI**j *= risk index for project *j*

*r *= cost of capital

Substitute each project’s risk index into this equation to determine its
RADR.

*c. *Use the RADR for each project to determine its *risk-adjusted NPV. *Which
project

is preferable in this situation?

*d. *Compare and discuss your findings in parts *a *and *c. *Which project
do you recommend

that the firm accept?

P12-12

*Risk classes and RADR *Moses Manufacturing is attempting to select the
best of

three mutually exclusive projects, X, Y, and Z. Although all the projects
have 5-year

lives, they possess differing degrees of risk. Project X is in class V, the
highest-risk

class; project Y is in class II, the below-average-risk class; and project
Z is in class

III, the average-risk class. The basic cash flow data for each project and
the risk

classes and risk-adjusted discount rates (RADRs) used by the firm are shown
in the

following tables.

* Project X
 Project Y Project Z*

*Initial investment (**CF**0**)
-$180,000 -$235,000 -$310,000*

*Year (**t**)
 Cash
inflows (**CF**t**)*

1 $80,000
 $50,000 $90,000

2 70,000
 60,000 90,000

3
60,000 70,000 90,000

4 60,000
 80,000 90,000

5 60,000
 90,000 90,000

*Risk Classes and RADRs*

*Risk class Description Risk-adjusted discount rate
(RADR)*

I Lowest risk 10%

II Below-average risk
 13

III Average risk 15

IV Above-average
risk 19

V Highest risk 22

*a. *Find the *risk-adjusted NPV *for each project.

*b. *Which project, if any, would you recommend that the firm undertake?

P12-14

*Unequal lives: ANPV approach *Portland Products is considering the
purchase of

one of three mutually exclusive projects for increasing production
efficiency. The

firm plans to use a 14% cost of capital to evaluate these equal-risk
projects. The initial

investment and annual cash inflows over the life of each project are shown
in the

following table.

* Project X
Project Y Project Z*

*Initial investment (**CF**0**) -$78,000
-$52,000 -$66,000*

*Year (**t**) Cash
inflows (**CF**t**)*

1 $17,000
$28,000 $15,000

2 25,000
38,000 15,000

3 33,000 -
 15,000

4 41,000
- 15,000

5
- - 15,000

6
- - 15,000

7
- - 15,000

8
- - 15,000

*a. *Calculate the *NPV *for each project over its life. Rank the projects
in descending

order on the basis of NPV.

*b. *Use the *annualized net present value (ANPV) *approach to evaluate and
rank the

projects in descending order on the basis of ANPV.

*c. *Compare and contrast your findings in parts *a *and *b. *Which project
would you

recommend that the firm purchase? Why?

P12-18

*Capital rationing: IRR and NPV approaches *Valley Corporation is
attempting to select

the best of a group of independent projects competing for the firm’s fixed
capital

budget of $4.5 million. The firm recognizes that any unused portion of this
budget

will earn less than its 15% cost of capital, thereby resulting in a present
value of inflows

that is less than the initial investment. The firm has summarized, in the
following

table, the key data to be used in selecting the best group of projects.

*Project Initial investment
IRR Present value of inflows at 15%*

A -$5,000,000 17%
 $5,400,000

B 2800,000
18 1,100,000

C 22,000,000
19 2,300,000

D 21,500,000 16
 1,600,000

E 2800,000
22 900,000

F 22,500,000 23
 3,000,000

G 21,200,000 20
 1,300,000

*a. *Use the *internal rate of return (IRR) approach *to select the best
group of projects.

*b. *Use the *net present value (NPV) approach *to select the best group of
projects.

*c. *Compare, contrast, and discuss your findings in parts *a *and *b.*

*d. *Which projects should the firm implement? Why?