Chapter SixThe Analysis of Investment ProjectsThis chapter contains 41 multiple choice problems, 20 short problems and 8 longer problems.Multiple Choice1.The objective of a firm's management is to only undertake the projects that ________ themarket value of shareholders' equity.a)decreaseb)do not decreasec)changed)do not changeAnswer: (b)2.The decision rule that management uses with the net present value is to undertake only thoseprojects with ________ NPV.a) a discountedb) a contingentc) a positived)negativeAnswer: (c)3.If a firm decides to invest in automated machines that will allow the firm to reduce laborcosts, this is an example of a ________ capital expenditures project.a)new productsb)replacement of existing assetsc)cost reductiond)advertisingAnswer: (c)4.The NPV of a project represents the amount by which it is expected to increase ________.a)the break-even pointb)capital budgetingc)capital expendituresd)shareholder wealthAnswer: (d)5.Consider the following annual cash flows:Year Cash Flows (in thousands of dollars)0 –2,0001 1,2002 1,5003 1,800Using a cost of capital of 15%, compute this project's NPV.a)$5,361,000b)$3,548,000c)$3,361,000d)$1,361,000Answer: (d)6.Consider the following annual cash flows:Year Cash Flows (in thousands of dollars)0 –5,0001 4,1002 3,8003 3,500Using a cost of capital of 12%, compute this project's NPV.a)$14,181,000b)$9,181,000c)$4,181,000d)$3,548,000Answer: (c)7. A negative sign in front of a cash-flow forecast for a particular year means that it is an________.a)inflowb)outflowc)indeterminate flowd)more information is required to make this determinationAnswer: (b) cash inflows from operations can be computed in which of the following ways?a)Cash Flow = Revenue – Cash Expenses – Taxesb)Cash Flow = Net Income + Noncash Expensesc)Cash Flow = Revenue – Total Expenses – Taxes + Noncash Expensesd)all of the aboveAnswer: (d)9.Consider the development of a new type of laptop machine. In your estimates you determinethat you will sell 5,000 laptop units per year at a price of $2,500 per laptop. Productionequipment will have to be purchased at a cost of $2 million. The equipment will bedepreciated over five years using the straight-line method. Net working capital of $1.9million will also required to finance this project. The cash expenses for this project are $1,700 per laptop. The tax rate is 40%. Compute the net cash inflows from operations.a)$4 millionb)$2.56 millionc)$2.16 milliond)$1.76 millionAnswer: (b)10.Refer to question 9. What is the annual depreciation amount for this project?a)$4 millionb)$1 millionc)$0.78 milliond)$0.4 millionAnswer: (d)11.Refer to question 9. If we use a cost of capital equal to 13%, what is the NPV for this project?a)$2.3 millionb)$3.7 millionc)$5.1 milliond)$9 millionAnswer: (c)12.In computing a project's cost of capital the risk to use is ________.a)the risk of the financing instruments used to fund the projectb)the risk of the project's cash flowsc) a risk-free rated) a historical risk rate using T-billsAnswer: (b)13.A capital budgeting project's cost of capital should reflect only the ________ risk of theproject, not the project's ________ risk.a)unsystematic, systematicb)unsystematic, market-relatedc)systematic, unsystematicd)systematic, market-relatedAnswer: (c)14.The point of indifference between accepting and rejecting a project is referred to as the________ point.a)paybackb)NPVc)rejectiond)break-evenAnswer: (d)15.Consider a project that has total fixed costs of $400,000, an annual depreciation (based on thestraight-line method) of $150,000, annual cash flows of $255,000, and a tax rate of 34%. The difference between the revenue and variable cost (on a per unit basis) is $1,600 (so we use 1,600Q). Determine the break-even volume for this project.a)Q = 443 unitsb)Q = 349 unitsc)Q = 230 unitsd)Q = 194 unitsAnswer: (b)16.For a project, an initial cash outlay of $1.4 million is made. In year 1 the expected annualcash flow is $900,000, years 2-5 the expected annual cash flow is $1,000,000 and in year 6 the expected annual cash flow is $1.3 million. A cost of capital of 15% is used. The IRR (internal rate of return) is ________.a)72.1%b)65.8%c)51.7%d)40.0%Answer: (b)17.An initial cash outlay of $1.4 million is made for a capital budgeting project. In year 1, theexpected annual cash flow is $900,000, years 2-5, the expected annual cash flow is$1,000,000 and in year 6, the expected annual cash flow is $1.3 million. If a cost of capital of 15% is used, compute the NPV of this project.a)$1,800,000b)$2,100,000c)$2,427,225d)$3,296,790Answer: (c)18.The ________ is defined as the annual cash payment that has a present value equal to theinitial outlay.a)annualized cost of debtb)cost of debtc)cost of financingd)annualized capital costAnswer: (d)19.Project A has an initial $3.5 million capital outlay which is converted into an equivalentseven year annuity at a discount rate of 12% per year. Project B has a $7 million initial capital outlay and will last for 14 years. Project B has the same discount rate as Project A. What is the preferred alternative based on the annualized capital cost?a)Project A; its annualized capital cost = $528,050b)Project A; its annualized capital cost = $766,912c)Project B; its annualized capital cost = $1,056,099d)Project B; its annualized capital cost = $1,533,824Answer: (b)20.Project A has an initial capital outlay of $3 million. It will be converted into an equivalent 5year annuity at a discount rate of 12% per year. Project B has an initial capital outlay of $6 million. It will be a ten year annuity at the same discount rate as Project A. What are the annualized capital costs of both projects?a) a. Project A: $832,229 Project B: $1,664,458b) b. Project A: $530,952 Project B: $1,664,458c) c. Project A: $832,229 Project B: $1,061,905d) d. Project A: $530,952 Project B: $1,061,905Answer: (c)21.In comparing alternative annualized capital costs, the alternative with the ________annualized capital cost is the preferred alternative.a)lowestb)highestc)zerod)amortizedAnswer: (a)22.A project's IRR is ________ its scale, which makes IRR not a good measure for rankingmutually exclusive projects.a)contingent onb)independent ofc)inversely proportional tod)half ofAnswer: (b)23.The ________ rate is the rate that prevails in a zero-inflation scenario. The ________ rate isthe rate that one actually observes.a)nominal, inflationb)real, expectedc)nominal, reald)real, nominalAnswer: (d)24.If the nominal cost of capital is 16% per year and the expected rate of inflation is 5% per year,then compute the real cost of capital.a)21.8%b)11.5%c)11%d)10.5%Answer: (d)25.The nominal rate of interest is 15.7% and the expected rate of inflation is 6%. Compute thereal rate of return.a)22.6%b)10.9%c)9.15%d)7.85%Answer: (c)Use the following table to solve questions 26 through 28.Year Real Cash Flow Nominal Cash Flow1 800,000 840,0002 800,000 882,0003 800,000 926,1004 800,000 972,405In the above table, the real cost of capital is 11% per year, and the expected rate of inflation is 5% per year. The initial outlay for this project is $1.5 million.ing the information given above, determine the nominal cost of capital.a)16.55%b)15.45%c)11.66%d) 5.7%Answer: (a)pute the NPV of the real cash flows.a)$714,189b)$981,957c)$1,009,971d)$1,290,317Answer: (b)pute the NPV of the nominal cash flows.a)$714,189b)$981,957c)$1,009,971d)$1,290,317Answer: (b)29.How can NPV be properly calculated?a)by using the nominal cost of capital to discount nominal cash flowsb)by using the real cost of capital to discount real cash flowsc)neither (a) nor (b)d)both (a) and (b)Answer: (d)Use the following information to answer questions 30 through 35:A new type of candy bar is being considered by ChocoLicious. This project is completelyindependent of all the other projects at ChocoLicious. An outlay of $3.1 million is required for equipment to produce the new product, and additional net working capital in the amount of $1.5 million is also required. The firm will recover all working capital at the end of the project. The project will be terminated in five years and the equipment will be fully depreciated over fiver years using the straight-line method. Revenues are expected to be $5 million per year during the project, while operating expenses (excluding depreciation) for the project are expected to be $2 million per year. There will be an additional $0.5 million working capital requirement during the first year, and no working capital additions beyond that time. The required rate of return for this project is 12% and the relevant tax rate is 40%. Calculate the NPV of this project.30.What is the annual depreciation?a)$0.62 millionb)$0.81 millionc)$0.92milliond)$1.54 millionAnswer: (a)31.What is the net cash flow in year 1?a)$1.428 millionb)$1.548 millionc)$2.048 milliond)$2.458 millionAnswer: (b)32.What is the total cash flow in year 3?a)$1.428 millionb)$1.548 millionc)$2.048 milliond)$2.458 millionAnswer: (c)33.What is the total cash flow in year 5?a)$2.048 millionb)$2.548 millionc)$3.548 milliond)$4.048 millionAnswer: (d)34.Which is closest to the NPV of the project?a)$2.34 millionb)$2.78 millionc)$3.47 milliond)$3.92 millionAnswer: (c)35.What is the IRR of project?a)34.35%b)35.23%c)37.35%d)39.29%Answer: (d)36.Apex Corporation is considering the purchase of Zenith Corporation. The owners of ZenithCorporation are asking $75 million in cash and the managers of Apex Corporation estimate that, once under their control, Zenith Corporation will generate cash flows of $20 million per year for five years. The cash flows are net of taxes. The IRR of this investment is ________.a)8.17%b)10.42%c)15.34%d)20%Answer: (b)37.BGB Corporations is considering a project that will pay nothing for the first three years,$80,000 in the fourth year, $120,000 in the fifth year, and $160,000 in the sixth year. The appropriate discount rate is 8.8% and the project requires an investment tomorrow of$150,000 if we accept the project. The NPV of this project is:a)$149,135b)$124,939c)$94,901d)$82,263Answer: (d)Use the following information to answer questions 38 through 41.NetProducts Inc. is considering installing a new server. The new machine costs $61,000 and is expected to have a useful economic life of 5 years, after which it will have a book value of $0. In addition to the equipment costs, management expects installation costs of $9,000 and an initial outlay for net working capital of $7,000.The new server is expected to generate an additional $16,000 per year in earnings after tax over its useful life, but an additional $4,000 per year is required in net working capital. The net working capital will be recovered by the end of the fifth year. NetProducts Inc. has cost of capital (k) of 20%.38.What is the net cash flow in year 1?a)$12,000b)$26,000c)$30,000d)$34,000Answer: (b)39.What is the total cash flow in year 5?a)$26,000b)$30,000c)$46,000d)$53,000Answer: (d)40.What is the NPV of this project?a)$11,606.59b)$8,793.45c)$5,176.55d)$755.90Answer: (a)41.What is the IRR of this project?a)30.03%b)26.01%c)22.88%d)20.45%Answer: (b)Short Problems1.Explain why the internal rate of return (IRR) is not a good measure for ranking mutuallyexclusive projects.Answer: In some cases the ranking system according to IRR may be inconsistent with the objective of maximizing shareholder value. IRR is not a good measure for rankingmutually exclusive projects since a project's IRR is independent of its scale.2.You are considering two investment projects with the following patterns of expected futurenet after-tax cash flows:Year Project A Project B0 –$9 million –$9 million1 $2 million $4.0 million2 $2.5 million $3.5 million3 $3.0 million $3.0 million4 $3.5 million $2.5 million5 $4.0 million $2.0 millionFor both projects, the appropriate cost of capital is 11%. Which project would yourecommend and why?Answer:NPV A= PV – initial outlay= $1,703,796NPV B= PV – initial outlay= $2,471,586Project B is better than Project A3.Consider an investment that requires an initial outlay of $3 million. In the absence of inflationthis investment is expected to produce an annual after-tax cash flow of $800,000 for six years.The cost of capital for this project is 12%. Compute the NPV and internal rate of return (IRR) of this investment. Does this seem a worthwhile investment?Answer:NPV = PV – initial outlay= $289,126IRR = 15.34%NPV > 0and IRR > cost of capitalThis appears to be a worthwhile investment based on NPV and IRR.4.Projects requiring capital expenditures fall into three categories. What are they? Discuss howideas for investment projects evolve.Answer:Most investment projects requiring capital expenditures fall into three categories:new products, cost reduction, and replacement of existing assets. Ideas forinvestment projects can come from customers and competitors, or from within thefirm's own R&D or production departments.5.Explain the manner in which firms use (or should use) the cost of capital in computing the netpresent value for a project.Answer:The correct cost of capital is the one applicable to firms in the same industry asthe new project. If the project happens to be a "mini-replica" of the assetcurrently held by the firm, then management should use the firm's cost of capitalin computing the project's NPV.6. A firm is considering investing $15 million in machinery equipment that is expected to have auseful life of five years and is expected to reduce the firm's labor costs by $5 million per year.Assume the firm pays a 35% tax rate on accounting profits and uses the straight-linedepreciation method. What is the after-tax cash flow from the investment in years 1 through 5?If the hurdle rate for this investment is 16% per year, is it worthwhile? What are theinvestment's IRR and NPV?Answer:Increase in after-tax cash flow = Increase in before tax cash flow – increase intaxes= $5,000,000 – (5,000,000 – 3,000,000)(0.35)= $4,300,000NPV = PV - Initial Outlay= 14,079,463 – 15,000,000= -$920,537IRR = 13.34%This is not a worthwhile project based on NPV and IRR.7.Consider two projects but the projects last for different periods of time. Project A has aninitial outlay of $5 million and is expected to generate an equivalent 5 year annuity at adiscount rate of 11%. Project B requires twice the initial outlay, but will last ten years at the same discount rate. Which is the preferred project based on annualized capital cost?Answer:Project A:n I PV FV PMT5 11% -5,000,000 0 ?PMT = $1,352,852 per yearProject B:n I PV FV PMT10 11% -10,000,000 0 ?PMT = $1,698,014 per yearProject A is the preferred alternative because it has the lower annualized capitalcost.8.Consider the following mutually exclusive projects, for a firm using a discount rate of 10%:Project Initial Investment NPV IRRA $1,000,000 $100,000 10.2%B $100 $1 11%C $50,000 $70,000 23%D $200,000 $24,000 13%Which project should the firm accept?Answer: Note the scaling differences associated with these projects, and the conflicting NPV and IRR results. In such cases, the project with the highest NPV should be chosen. Therefore the firm should accept Project A.9.Two projects being considered are mutually exclusive and have the following projected cashflows:Year Project A Project B0 –$50,000 –$50,0001 0 15,6252 0 15,6253 0 15,6254 0 15,6255 99,500 15,625If the required rate of return on these projects is 10 percent, which should be chosen and why?Answer: Calculate net present value of each project and choose the project with thehigher NPV.Net Present Value (Project A) = $11,781.67Net Present Value (Project B) = $9,231.04Choose Project A.10.Consider the following mutually exclusive, average risk projects, for a firm with a discountrate of 9%:Project Initial Investment NPV IRRA $100 $1 11%B $25,000 $35,000 23%C $500,000 $50,000 10.2%D $100,000 $12,000 13%Which project should the firm accept?Answer:Choose Project C – it has the highest NPV.Note the scaling differences associated with these projects, and the conflicting NPV and IRR results. In such cases, the project with the highest NPV should be chosen. Therefore the firm should accept Project C.11.You are evaluating two mutually exclusive projects for Licorice Inc., with the following netcash flows:Year Project A Project B0 $(100,000) ($100,000)1 55,000 35,0002 45,000 38,0003 40,000 41,0004 35,000 42,0005 0 45,000If Licorice's cost of capital is 15%, which project should you choose?Answer:Choose the project with the higher NPV.Net Present Value (Project A) = $28,164.56Net Present Value (Project B) = $32,513.00Choose Project B.12.Pluto Inc. is considering the purchase of Neptune Corp. The owners of Neptune Corp. areasking for $150 million in cash. The managers of Pluto estimate that, under their control, Neptune Corp. will generate cash flows of $12 million per year for five years and then be sold for $200 million. The IRR of this investment is:Answer:First of all, set up the cash flows associated with this investment:Year Cash Flow___0 ($150,000,000)1-4 $12,000,000/yr5 $212,000,000Using a cash flow worksheet, the IRR = 13.13% per year.13.You are evaluating two independent projects for Licorice Corporation, with the following netcash flows:Year Project A Project B0 –$100,000 –$100,0001 55,000 35,0002 45,000 38,0003 40,000 41,0004 35,000 42,0005 0 45,000If Licorice Corp's cost of capital is 9%, which project(s) should be accepted?Answer:Net Present Value (Project A) = $44,016.54Net Present Value (Project B) = $54,754.23Note that these are independent projects; accepting one does not preclude accepting the other. Since both projects have positive NPVs, both should be accepted.14.Oscar’s Corp. is considering starting a new business involving bicycle production. This newbusiness involves purchases of $8 million of new equipment. This new business is anticipated to generate net income of $1.43 million per year for 6 years. The company uses straight-line depreciation to zero salvage value for tax purposes. Assuming a 30 percent tax rate and a 10 percent discount rate, calculate the project's IRR.Answer:Dep = ($8,000,000)/6= $1,333,333/yrAnnual cash flow = Net income + noncash charges= $1.43 million + $1,333,333= $2763,333/yrCalculate the internal rate of return = 25.85%Since IRR > discount rate, accept project.15.Brunhilde Corporation is considering a project that will pay $10,000 at the end of the firstyear, $20,000 at the end of the second year, and $40,000 at the end of the third year. The project's appropriate discount rate is 11% and it will require an investment tomorrow of$50,000 if accepted. Calculate the NPV of this project.Answer:The cash flows for this project are:Year Cash flow0 ($50,000)1 10,0002 20,0003 40,000NPV (@ 11% discount rate) = $4,489.1116.You are analyzing a capital budgeting project and, as shown by ???, some numbers areunreadable. You can read the following information:Cash Flows at the end of: Year 0 = ($24,300)Year 1 = $10,800Year 2 = $ 6,000Year 3 = $ 2,600Year 4 = $ ???Year 5 = $ 9,300The Cost of Capital is 13%, the NPV = –$2,663.48 and the IRR = ???%. Your superior, ignoring the important fact that we should reject the project, is demanding to know the Cash Flow in Year 4. Calculate the cash flow in Year 4.Answer:Solve the expression:10,800/1.13 + 6,000/(1.13)2 + 2,600/(1.13)3 + ???/(1.13)4 + 9,300/(1.13)5 –24300 =–2,663.48??? = $86517.Consider the following normal, independent projects that are being considered for next year'scapital budget. The firm had been using a cost of capital of 16%, but recently found out that the correct cost of capital was 10%. Your firm uses discounted cash flow methods (NPV, IRR) to choose projects. You are given the following information.Project Initial Investment NPV@16%IRRA $1,000,000 –$200,000 13.9%B $4,000,000 –$900,000 11.1%C $2,000,000 –$180,000 8.4%Note, the above information is correct except that the NPVs were calculated using 16%instead of 10%. Which project(s) should the firm accept?Answer: Since the cost of capital has decreased, the NPV for each project will change.However, we do not have the annual cash flows that we need to recompute NPV. Insteadwe consider IRR. Now Project A and Project B have IRRs greater than the cost of capital.The firm should accept projects A and B.18.You are considering two different pieces of equipment for your business. Either of them willserve your purpose equally well; however, they have different acquisition costs, operating costs, and useful lives. The specific characteristics of each piece of equipment are:Machine A Machine B Acquisition cost $50,000 $70,000Operating cost per annum 10,000 9,000Useful life 3 years 5 years Salvage value 0 0If you anticipate remaining in business for at least 15 years, and your discount rate is 10%, which machine should you select?Answer:PV of costs (Project A) = 50,000 + 24,868.52 = $74,868.52PV of costs (Project B) = 70,000 + 34,117.08 = $104,117.08Now determine which project is the cheaper alternative. Calculate the annualized cost:Project A:PV I N Result___________-74,868.52 10 3 PMT = $30,105.74Project B:PV I N Result___________-104,117.08 10 5 PMT = $27,465.82Choose Project B since its annualized cost is lower than that of Project A.19.Consider the following normal, independent projects that are being considered for nextyear’s capital budget. The firm had been using a cost of capital of 17%, but recently found out that the correct cost of capital was 10%. Your firm uses discounted cash flow methods (NPV,IRR) to choose projects. You are given the following information about the projects.Project Initial Investment NPV@17% IRRA $2,000,000 –$1,470,000 8.4%B $6,000,000 –$1,200,000 11.1%C $1,500,000 –$450,000 13.9%Note, the above information is correct except that the NPVs were calculated using 17% instead of 10%. Which project(s) should the firm accept?Answer:Since the cost of capital has decreased, this may change our assessment of the projects.To recompute the NPV, we need the annual cash flows, which are not displayed, so weneed to take a look at IRR instead. Now Projects B & C have IRRs greater than the cost of capital. The firm should accept Project B and Project C.20.Makine Corp. is considering a new business. This business involves startup costs of $13million. This business is anticipated to generate net income of $1.35 million per year for 13 years. The company uses straightline depreciation to zero salvage value for tax purposes.Assuming a 30 percent tax rate and a 10 percent discount rate, calculate the project’s NPV.Answer:Annual depreciation = $13 million/13= $1 millionAnnual net cash flow = net income + depreciation= 1.35 million + $1 million= $2.35 millionNPV = $3,692,887Longer Problems1.Reyes Inc. is considering investing $8 million in computer equipment that is expected to havea useful life of 4 years, and is expected to reduce the firm’s labor costs by $3 million peryear. Assume that Reyes, Inc. pays a 35% tax rate on accounting profits and uses the straight-line depreciation method. What is the after-tax cash flow from the investment in years 1through 4? If the firm's hurdle rate for the project is 14% per year is it worthwhile? What are the investment's NPV and IRR?Answer:Increase in after-tax cash flow = Increase in before tax cash flow –increase in taxes= $3 million – (3 – 2 million)(0.35)= $3 million – $0.35 million= $2.65 millionNPV = PV – Initial Outlay= $7,721,338 – $8,000,000= -$278,662IRR = 12.29%Based on NPV and IRR, the project does not seem worthwhile.2.Consider a project which involves an initial outlay of $5 million and which will generate anexpected annual cash flow of $1.6 million. The cost of capital used is 13%. This project will last 6 years.(a) Compute the project's NPV(b) Compute the IRRAnswer:(a) NPV = PV - Initial Outlay= $6,396,080 – $5,000,000= $1,396,080(b) IRR = 22.56%3.Sound Wired Corporation is considering an investment of $1,000,000 in equipment forproducing a new type of compact disc. The equipment has an expected life of five years.Sales are expected to be 150,000 units per year at a price of $25 per unit. Fixed costsexcluding depreciation of the equipment are $300,000 per year, and variable costs are $13 per unit. The equipment will be depreciated over five years using the straight-line method with a zero salvage value. Working capital requirements are assumed to be 1/12 of annual sales. The market capitalization rate for the project is 17% per year, and the corporation pays income tax at the rate of 35%. What is the project's NPV? What is the break-even volume?Answer:Sales revenue = $25 per unit x 150,000 units per year= $3,750,000 per yearInvestment in NWC = 1/12 x $3,750,000= $312,500Total investment = $1,000,000 + $312,500= $1,312,500Depreciation = $1,000,000 / 5= $200,000 per yearTotal annual operating costs = $13 x 150,000 + $500,000= $2,450,000 per yearCF = net income + depreciation= (1 - 0.35)(3,750,000 - $2,450,000) + $200,000= $1,045,000 per yearNPV = PV - Initial Outlay= $3,343,317 - $1,312,500= $2,030,817To determine break-even volume:In order for NPV to be 0, what must the cash flow from operations be?N I PV FVPMT5 17% -1,312,500 312,500 ?PMT = $365,689Cash Flow = Net profit + Depreciation$365,689 = 0.65 (12Q – 500,000) + 200,000$365,689 = 7.8Q – 325,000 + 200,000$365,689 = 7.8Q – 125,000$490,000 = 7.8Q62,909 = QSo the break-even volume is 62,909.4.In anticipation of the year 2008 Olympics in Beijing, China, TingTing Inc. is consideringgetting into the souvenir business. One idea under consideration is the production of panda bear statuettes. A machine costing $60,000 will have to be purchased and this new machine will have a life of three years (for both actual and tax purposes) and after three years the machine will have zero salvage value. In terms of depreciation, the machine will bedepreciated on a straight-line basis. TingTing Inc. believes it can sell 5,000 souvenir statues per year at a price of $15 each. For each statue the variable costs are $3 and fixed expenses (this does not include depreciation) will be $4,000 per year. The cost of capital for TingTing Inc. is 14% and the tax rate is 35%. The figures given above assume that there will be no inflation.(a) Compute the series of expected cash flows.(b) Compute the project's NPV. Is it a worthwhile project?(c) What is the NPV breakeven quantity?Now assume that over the next three years the expected rate of inflation is 7% per year.Also assume that in this environment both revenues and nondepreciation expensesincrease at that rate and the cost of capital remains the same.(d) Compute the series of expected nominal cash flows.(e) Compute the NPV of nominal cash flows. Is the project worth undertaking?Answer:(a) Increase in revenue = $75,000Fixed costs (ex. dep) = $4,000Depreciation = $20,000Total Fixed Cost = $24,000Total variable costs = $15,000Total operating costs = $39,000Operating Profit = $36,000Taxes = $12,600After-tax operating profit = $23,400Net Cash Flow = $43,400 in each of the next three yrs.(b) NPV = PV – Initial Outlay= $100,759 – $60,000= $40,759The project is worthwhile(c) n I PV FV PMT3 14% –60,000 0 ?PMT = $25,844Incremental cash flow = Increase in net profit + increase in depreciation$25,844 = 0.65(12Q - 24,000) + 20,000Q = 2,749 units per year(d) CF1= $43,400(1.07) = $46,438CF2= $46,438(1.07) = $49,688.66CF3= $49,688.66(1.07) = $53,167。
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