Week 8 Homework 2024_Chaitanya

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Webster University *

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5200

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Finance

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Apr 3, 2024

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Week 8 Homework 2024 1. For managers to maximize the wealth of the firm's owners, they must choose projects that return higher than the cost of capital . 2. Capital Budgeting provides a way to decide which investments should be undertaken or rejected such that the value of the firm is maximized. 3. What type of cash flows occur if the project is undertaken, but won’t occur otherwise? Answer: Incremental cash flows that occurs if the project is undertaken but won’t occur otherwise. 4. What is the key term that the lecture refers to when Total Revenue = Total Cost Answer: Breakeven point is the key term that the lecture refers to when Total Revenue = Total Cost. 5. Which projects are usually not evaluated using capital budgeting techniques. Answer: The projects are usually not evaluated using capital budgeting techniques are:  Profitability Index (PI)  Discounted Payback (DPB)  Modified Internal Rate of Return (MIRR) 6. According to the lecture, what projects are generally evaluated using capital budgeting techniques? Answer: The projects are generally evaluated using capital budgeting techniques are:  Payback Period Method (PB)  Breakeven Analysis  Breakeven Chart  Net Present Value (NPV) Method  Internal Rate of Return (IRR) 7. The Internal Rate of Return of a project is formally defined as that rate of return which, in the NPV equation, produces an NPV of zero. 8. What is the name of the chart that plots total revenue (TR) against total cost (TC) Answer: The chart that plots total revenue (TR) against total cost (TC) is a breakeven chart . 9. When considering capital projects, the ultimate objective of a financial manager is to determine the alternative that most maximize the value of firm .

10. Roberts and Company is considering investing in a project with the cash flows shown as follows, and that the required rate of return on projects of this risk class is 8 percent. Time 0 1 2 3 4 5 Cash flow -200,000 85,000 55,000 45,000 35,000 25,000 Calculate the NPV. Using only the NPV decision rule to evaluate this project; should it be accepted or rejected? Answer: To calculate the Net Present Value (NPV) of the project, we'll discount each cash flow back to the present value and then sum them up: NPV = Σ (CFt / (1 + r) ^ t) Where: CFt = Cash flow at time t r = Discount rate (8% in this case) t = Time period Here are the calculations: NPV = (-200,000 / (1 + 0.08) ^ 0) + (85,000 / (1 + 0.08) ^ 1) + (55,000 / (1 + 0.08) ^ 2) + (45,000 / (1 + 0.08) ^ 3) + (35,000 / (1 + 0.08) ^ 4) + (25,000 / (1 + 0.08) ^ 5) NPV = $4,320.41 . 11. Given the same information in question #10, calculate the payback. Answer: To calculate the payback period, we sum the cash flows until they equal the initial investment. Payback Period = Number of years before full recovery of initial investment Initial Investment = $200,000 Cash flows: 1st Year = $85,000 2nd Year = $55,000 3rd Year = $45,000 4th Year = $35,000 5th Year = $25,000 1st Year = -$200,000 + $85,000 = -$115,000 2nd Year = -$115,000 + $55,000 = -$60,000

3rd Year = -$60,000 + $45,000 = -$15,000 4th Year = -$15,000 + $35,000 = $20,000 The initial investment is recovered in Year 4, leaving an extra $20,000. Because the original investment is not entirely recovered by the end of Year 3, but is repaid before the end of Year 4, the payback time is expected to be between Years 3 and 4. To get a more precise estimate, we may compute the percentage of a year required to fully recoup the initial investment after Year 3: percentage of Year 4 needed for full recovery = $15,000 / $35,000 = 0.4286. Thus, the payback period is roughly 3.43 years. 12. Tammy Tasty Treats is considering investing in a project to streamline their production process. The cash flows are shown below. The required rate of return for projects of this class is 8%. Time 0 1 2 3 4 5 6 Cash flow -300,000 95,000 85,000 25,000 35,000 25,000 10,000 Calculate the NPV Using only the NPV to evaluate this project, should it be accepted? Answer: To calculate the NPV of the project, we'll use the formula: NPV = ∑ t = 0 n ❑ C F t ¿¿ Where: CFt = Cash flow at time t r = Required rate of return n = Number of periods Substituting the given values: NVP=(−300,000/(1+0.08)^0) + (95,000/(1+0.08)^1) + (85,000/(1+0.08)^2) + (25,000/(1+0.08)^3) + (35,000/(1+0.08)^4) + (25,000/(1+0.08)^5) + (10,000/(1+0.08)^6) NVP = -70275.11 13. Given the same information in #12, what is the cash flow for this project? Answer:  Net Cash Flow = -$300,000 + $95,000 + $85,000 + $25,000 + $35,000 + $25,000 + $10,000 Net Cash Flow = -$25,000

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 Cash flow for this project is -$25,000. Therefore, the net cash flow for this project is $25,000. 14. Stanley and company are considering investing in two mutually exclusive projects. Projects A and project B. The cash flows for each project are shown below. Project A Time 0 1 2 3 4 5 6 Cash flow -300,000 100,000 125,000 75,000 55,000 25,000 10,000 Project B Time 0 1 2 3 4 5 6 Cash flow -250,000 55,000 165,000 10,000 35,000 35,000 12,000 Calculate the payback for each project. Based on the payback, which project should be accepted? Show your calculations. Answer: The payback period represents the duration required for an investment to produce earnings or cash flow equal to the initial investment amount. This is determined by accumulating cash inflows until they match the initial outlay. Now, we will compute the payback period for each project. Project A: 1st Year = -300,000 + 100,000 = -200,000 2nd Year = -200,000 + 125,000 = -75,000 3rd Year = -75,000 + 75,000 = 0 So, the payback period for Project A is 3 years. Project B: 1st Year = -250,000 + 55,000 = -195,000 2nd Year = -195,000 + 165,000 = -30,000 3rd Year = -30,000 + 10,000 = -20,000 4th Year = -20,000 + 35,000 = 15,000 Therefore, Project B has a payback period of 4 years. However, it is crucial to acknowledge that solely considering the payback period is insufficient in making an investment decision. Project A should be favored due to its shorter payback period, but it is essential to recognize that the payback period fails to account for factors such as the time value of money, risk, opportunity cost, profitability, and return on investment. To ensure a comprehensive investment decision, it is advisable to utilize the payback period in conjunction with other project evaluation methods. 15. Staple and company is evaluating a new project with the following cash flows:

Initial investment Year 0 yr1 yr2 yr3 yr4 yr5 -150,000 25,000 35,000 40,000 50,000 25,000 The cost of capital is 6%. Calculate the IRR. Should the project be accepted or rejected? Answer: Investment planning and capital budgeting both employ the Internal Rate of Return (IRR), a critical financial statistic. It shows the percentage of discounting that a project's net present value (NPV) will equal. This basically means that it shows how quickly the initial investment is matched by the present value of future cash inflows. For the given project, the cash flows are as follows: Table Time Cash Flow 0 -150,000 1 25,000 2 35,000 3 40,000 4 50,000 5 25,000 0 = ∑ n = 0 N CF n ( 1 + IRR ) n Where, CFt = Cash flow at time t r = Discount rate n = Number of periods So, using a financial calculator, we find the value of IRR is 5.194. Therefore, the project's internal rate of return (IRR) was computed at 5.19%. This indicates that the project's return is 5.19%, which falls below the cost of capital of 6%. The cost of capital represents the return that a company could have achieved by investing the funds in an alternative opportunity with similar risk levels. According to the IRR decision rule, a project should be

accepted if its IRR exceeds the cost of capital. Conversely, if the IRR is lower than the cost of capital, the project should be declined. Given that the IRR of this project is below the cost of capital, it should be rejected in accordance with the IRR decision rule. 16. Susan and company are considering the purchase of a new piece of machinery. What would be the firms breakeven point in units given the data below? Show your calculations. Fixed Costs = 100 Price = 4 Variable Cost = .90 Answer: The breakeven point in units can be calculated using the formula: Breakeven Point in Units = Fixed Costs / Price per unit − Variable Cost per unit Given the fixed costs of $100, a price of $4 per unit, and a variable cost of $0.90 per unit, we can substitute these values into the formula: Breakeven Point in Units =100/4−0.90 Breakeven Point in Units =100/3.10 Breakeven Point in Units =32.26 We would need to sell about 33 units in order to pay the fixed expenses because we are unable to sell fractions of a unit. Consequently, Susan and Company's breakeven point is 33 units. Accordingly, in order to start turning a profit and pay for their fixed and variable expenditures, they would need to sell 33 units of their product. 118. 8.

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Related Questions

24 Some investment projects require that a company increase its working capital. Under the net present value method, the investment and eventual recovery of working capital should be treated as: A. an initial cash outflow. B. a future cash inflow. C. both an initial cash outflow and a future cash inflow. D. irrelevant to the net present value analysis.

15 The time value of money concept is given consideration in long-range investment decisions by Group of answer choices assuming equal annual cash flow patterns weighting cash flows with subjective probabilities assigning greater value to more immediate cash flows investing only in short-term projects

Question 29 PART 1 The stand-alone principle allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows. Which of the following cash flows are not relevant for our analysis of a new project? Group of answer choices Financing costs Opportunity costs Taxes Erosion or side effects Net working capital Question 29 PART 2 Will Smith once turned down the role to play Neo in “The Matrix.” The part went to Keanu Reeves. Will Smith instead chose to star as a cowboy in the blockbuster failure “The Wild Wild West.” Kevin Costner also once turned down the role to play Andy Dufresne in “Shawshank Redemption.” The part went to Tim Robbins. Kevin Costner instead chose to star as the Mariner in the blockbuster failure “Waterworld.” Based on the information above, what is one of the most relevant costs both Will Smith and Kevin Costner should consider when evaluating future movie projects? Group of answer choices Sunk…

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Mastery Problem: Net Present Value and Internal Rate of Return Part One Companies use capital investment analysis to evaluate long-term investments. Capital investment evaluation methods that use present values are (1) Net present value method (NPV) and (2) Internal rate of return (IRR) method. Methods That Use Present Values Of the two capital investment evaluation methods, a defining characteristic NPV and IRR is that they the time value of money. This means that money tomorrow is worth money today. And, that cash invested today has the potential to earn income and in value over time. True or False: When making an investment decision between two mutually exclusive projects, the project with the greatest return on investment should be chosen. Feedback Review the definition of Methods that use present value by rolling your mouse over the underlined item. Review the definition of Mutually Exclusive Projects by rolling your mouse over the underlined…

Incremental cash flows: a. refer to only cash flows which occur at the end of a project b. are cash flows which change if you proceed with the project c. refer to only cash flows which occur at the start of a project d. are never included in capital budgeting analysis e. refer to the existing cash flows of the business

20. Some investment projects require that a company expand its working capital to service the greater volume of business that will be generated. Under the net present value method, how should the investment of working capital be treated? Select one: a. An initial cash outflow for which no discounting is necessary. b. Both an initial cash outflow for which no discounting is necessary and a future cash inflow for which discounting is necessary. c. Irrelevant to the net present value analysis. d. A future cash inflow for which discounting is necessary.

Question 6 Which one of the following methods predicts the amount by which the value of a firm will change if a project is accepted? O Payback O Profitability index O Net present value O Internal rate of return O Discounted payback

NO1.1 Capital budgeting is the process that a business uses to determine which proposed fixed asset purchases (or projects) it should accept, and which should be declined. This process is used to create a quantitative view of each proposed fixed asset investment, thereby giving a rational basis for making a judgment. Analyze why, despite employing various investment appraisal techniques, large investment projects in big corporations may fail to deliver their estimated cash flows. Critically assess how a failed capital project may affect key stakeholders and shareholder value, and also shape the future strategy of investment capital

he difference between a firm’s future cash flows with a project and without the project is called Blank______ cash flows. Multiple choice question. investing discounted incremental operating

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