Managerial Economics: Applications, Strategies and Tactics (MindTap Course List)
Managerial Economics: Applications, Strategies and Tactics (MindTap Course List)
14th Edition
ISBN: 9781305506381
Author: James R. McGuigan, R. Charles Moyer, Frederick H.deB. Harris
Publisher: Cengage Learning
Question
Book Icon
Chapter 17, Problem 5E

a)

To determine

To describe: The internal rate of return and the net present value.

a)

Expert Solution
Check Mark

Answer to Problem 5E

The internal rate of return is approximately 15% and the NPV is close to zero.

Explanation of Solution

To purchase the contract of Bobcats, the net investment (NINV) is $800,000

The rate of return after tax is k=12%

Income tax rate is t=40%

The investment depreciates over the four year period.

So, the depreciation per year is $800,0004=$200,000

The net cash flow in each of the year calculated as,

    YearIncremental ReturnsDepreciationNet Cash Flow
    1$450,000$200,000($450,000$200,000)(10.6)+$200,000=$350,000
    2$350,000$200,000($350,000$200,000)(10.6)+$200,000=$290,000
    3$275,000$200,000($275,000$200,000)(10.6)+$200,000=$245,000
    4$200,000$200,000($200,000$200,000)(10.6)+$200,000=$200,000

The net present value (NPV) of the investment is,

  NPV=t=1nNFC ( 1+k )tNINV

So, the net present value (NPV) of the investment is,

  NPV=$350,000 ( 1+0.12 )1+$290,000 ( 1+0.12 )2+$245,000 ( 1+0.12 )3+$200,000 ( 1+0.12 )4$800,000=$312,000+$231,186+$174,377+$127,065$800,000=$45,128

Bcats should sign the superstars, as NPV>0

The internal rate of return (r) makes the net present value zero.

Let’s assume that r=13%

The net present value (NPV) of the investment is,

  NPV=$350,000 ( 1+0.13 )1+$290,000 ( 1+0.13 )2+$245,000 ( 1+0.13 )3+$200,000 ( 1+0.13 )4$800,000=$309,735+$227,113+$169,785+$122,699$800,000=$29,332

Now, let’s assume that r=14%

The net present value (NPV) of the investment is,

  NPV=$350,000 ( 1+0.14 )1+$290,000 ( 1+0.14 )2+$245,000 ( 1+0.14 )3+$200,000 ( 1+0.14 )4$800,000=$307,018+$223,146+$165,317+$118,413$800,000=$13,892

Now, again let’s assume that r=15%

The net present value (NPV) of the investment is,

  NPV=$350,000 ( 1+0.15 )1+$290,000 ( 1+0.15 )2+$245,000 ( 1+0.15 )3+$200,000 ( 1+0.15 )4$800,000=$304,348+$219,282+$161,078+$114,351$800,000=$941

At r=15% , the NPV is close to zero. So, the internal rate of return is approximately 15%

Economics Concept Introduction

Introduction:

The internal return rate (IRR) describes a metric used to estimate the return on potential investments for the purpose of capital budgeting. The internal rate of return is a discount rate equal to zero for a given project, the net present value (NPV) of all the cash flows.

b)

To determine

To describe: That Bcats should sign the superstars.

b)

Expert Solution
Check Mark

Answer to Problem 5E

Bcats should sign the superstars.

Explanation of Solution

Since the internal rate of return exceeds the required rate of return (r>k) , Bcats should sign the superstars.

Economics Concept Introduction

Introduction:

The internal return rate (IRR) describes a metric used to estimate the return on potential investments for the purpose of capital budgeting. The internal rate of return is a discount rate equal to zero for a given project, the net present value (NPV) of all the cash flows.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!
Students have asked these similar questions
1. Suppose that the two nations face the following benefits of pollution, B, and costs of abatement, C: BN = 10, Bs = 7; CN = 5, Cs = 4. Further assume that if the nation chooses to abate pollution, it still receives the benefits of pollution but now must pay the cost of abatement as well. a. Identify the payoffs that accrue to each nation under the four different possible outcomes of the game and present these payoffs in the normal form of the game. b. Recall that the term dominant strategy defines the condition that a player in a game would prefer to play that strategy (in this case either pollute or abate) regardless of the strategy chosen by the other player in the game. Does either nation have a dominant strategy in this game? If so, what is it? c. Identify the Nash equilibria, or non-cooperative equilibria, of this game.
agrody calming Inted 001 and me 2. A homeowner is concerned about the various air pollutants (e.g., benzene and methane) released in her house when she cooks with natural gas. She is considering replacing her gas oven and stove with an electric stove comprising an induction cooktop and convection oven. The new appliance costs $900 to purchase and install. Capping the old gas line costs an additional $150 (a one-time fee). The old line must be inspected for leaks each year after capping, at a cost of $35 for each inspection. a. If the homeowner plans to remain in the house for four more years and the discount rate is 4%, what is the minimum present value of the benefits that the homeowner would need to experience for this purchase to be justified based on its private net sub present value? b. While trying to understand how she might express the value of reduced exposure to indoor air pollutants in dollar terms, the homeowner consulted the EPA website and found estimates provided by…
After the ban is imposed, Joe’s firm switches to the more expensive biodegradable disposable cups. This increases the cost associated with each cup of coffee it produces. Which cost curve(s) will be impacted by the use of the more expensive biodegradable disposable cups? Why? Which cost curve(s) will not shift, and why not? Please use the table below to answer this question. For the second column (“Impacted? If so, how?”), please use one of the following three choices: No shift; Shifts up (i.e., increases: at nearly any given quantity, the cost goes up); or Shifts down (i.e., decreases: at nearly any given quantity, the cost goes down). $ Cost Curve Impacted? If so, how? Explanation of the Shift: Why or Why Not AFC No shift. Fix costs stay the same, regardless of quantity. Fixed cost is calculated as Fixed Cost/Quantity. Since fixed costs remain unchanged, AFC stays the same for each quantity. MC Shifts up. Since the biodegradable cups are more expensive, the…
Knowledge Booster
Background pattern image
Similar questions
SEE MORE QUESTIONS
Recommended textbooks for you
Text book image
Managerial Economics: Applications, Strategies an...
Economics
ISBN:9781305506381
Author:James R. McGuigan, R. Charles Moyer, Frederick H.deB. Harris
Publisher:Cengage Learning
Text book image
Managerial Economics: A Problem Solving Approach
Economics
ISBN:9781337106665
Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:Cengage Learning
Text book image
Microeconomic Theory
Economics
ISBN:9781337517942
Author:NICHOLSON
Publisher:Cengage
Text book image
Microeconomics: Private and Public Choice (MindTa...
Economics
ISBN:9781305506893
Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson
Publisher:Cengage Learning
Text book image
Economics: Private and Public Choice (MindTap Cou...
Economics
ISBN:9781305506725
Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson
Publisher:Cengage Learning
Text book image
Microeconomics A Contemporary Intro
Economics
ISBN:9781285635101
Author:MCEACHERN
Publisher:Cengage