Gitman: Principl Manageri Finance_15 (15th Edition) (What's New in Finance)
Gitman: Principl Manageri Finance_15 (15th Edition) (What's New in Finance)
15th Edition
ISBN: 9780134476315
Author: Chad J. Zutter, Scott B. Smart
Publisher: PEARSON
Question
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Chapter 10, Problem 1OR

a)

Summary Introduction

To determine:

NPV of the project.

Introduction:

The difference between the present value of cash inflows and the present value of cash outflows over a period of time is known as the Net Present value.

a)

Expert Solution
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Explanation of Solution

Given information:

The initial investment for the project is $67,800,000 and it generates an annual cash inflow of $30,450,000 for 5 years. The project NPV is $44,200,000 and the IRR is 34.8%.

Explanation:

The given information helps us to conclude that the project has a positive NPV and a very high IRR with initial outflow and subsequent cash inflows. Thus, the project should have a cost of capital less than the IRR value.

b)

Summary Introduction

To determine:

Cost of capital of the firm.

Introduction:

The difference between the present value of cash inflows and the present value of cash outflows over a period of time is known as the Net Present value. Cost of capital is the cost of long term financing of the firm.

b)

Expert Solution
Check Mark

Explanation of Solution

Given information:

The initial investment for the project is $67,800,000 and it generates an annual cash inflow of $30,450,000 for 5 years. The project NPV is $44,200,000 and the IRR is 34.8%.

 Explanation:

When the initial investment I0 ,annual cash flow (AC), rate of interest r, and the time period n is  given NPV can be calculated using the equation (1) ,

NPV=AC((1+r)n1)r(1+r)nI0 (1)

By trial and error method let us assume the cost of capital to be 0.11.

NPV=30,450,000(((1+0.11)51)0.11(1+0.11)5)67,800,000=(30,450,000×3.695897)67,800,000=112,540,06467,800,000=44,740,064

When substituting 11%, NPV is $44,740,064. Since the calculated NPV is greater than the given NPV, increase the interest rate 11.19%.

NPV=30,450,000(((1+0.1119)51)0.1119(1+0.1119)5)67,800,000=(30,450,000×3.6783)67,800,000=112,004,23867,800,000=44,204,238

When the interest rate is 11.19%, the NPV is nearly equal to the given NPV $44,200,000.  Thus, cost of capital of the firm is 11.19% (approx..).

c)

Summary Introduction

To determine:

The payback period of the firm.

Introduction:

Every investment requires a time period to pay back the cost of investment. The time period taken to recover the cost of an investment is known as the payback period.

c)

Expert Solution
Check Mark

Explanation of Solution

Given information:

The initial investment for the project is $67,800,000 and it generates an annual cash inflow of $30,450,000 for 5 years. The project NPV is $44,200,000 and the IRR is 34.8%.

Explanation:

Payback period for project can be calculated as follows:

Payback period=InitialinvestmentCash inflow per year=67,800,00030,450,000=2.226

The payback period for project is 2 years and 3 months.

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Chapter 10 Solutions

Gitman: Principl Manageri Finance_15 (15th Edition) (What's New in Finance)

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