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Offshore Drilling Products Inc, imposes a payback cutoff of 3 years for its international investment projects.
If the company has the following two projects available, should they accept either of them?
Cash Cash
Year Flow (A) Flow (B)
0 ($30,000) ($45,000)
1 15,000 5,000
2 10,000 10,000
3 10,000 20,000
4 5,000 250,000
Solution
Instructions
Enter formulas to calculate the cumulative cash flows and then calculate the payback period for
each investment.
Investment A Investment B
Cash Cumulative Cash Cumulative
Year Flow Cash Flow Flow (B) Cash Flow
0 ($30,000) ($45,000)
1 $15,000 $5,000
2 $10,000 FORMULA $10,000 FORMULA
3 $10,000 FORMULA $20,000 FORMULA
4 $5,000 FORMULA $250,000 FORMULA
What-if Analysis
Instructions
Click one of the scenario buttons to see the "what if" question. With each scenario, refer back to the
original data of the problem. Solve the scenario question by utilizing the payback template given below.
Be sure to print your results before moving on to the next scenario.
What-if:
(Scenario 1)
Cash Cash
Year Flow (A) Flow (B)
0 ($30,000) ($50,000)
1 10,000 10,000
2 10,000 15,000
3 5,000 60,000
4 5,000 250,000
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You’re trying to determine whether or not to expand your business by building a new manufacturing plant.
The following projections apply:
Projected
Year Net Income
1 $1,741,000
2 1,628,000
3 1,301,000
4 1,000,000
Solution
Instructions
Enter data and use the Excel AVERAGE function to calculate the AAR. Also use the SLN function to
calculate depreciation.
Installation cost
Year 1 2 3 4
Beginning BV
Annual depreciation FORMULA
Accumulated depreciation #VALUE! #VALUE! #VALUE!
Ending Book Value #VALUE! #VALUE! #VALUE! #VALUE!
AAR FORMULA
What-if Analysis
Instructions
Click one of the scenario buttons to see the "what if" question. With each scenario, refer back to the
original data of the problem. Solve the scenario question by utilizing the AAR template given below. Be
sure to print your results before moving on to the next scenario.
What-if: (Scenario 1)
The initial investment was only $10,000,000
Installation cost
Year 1 2 3 4
Beginning BV
Annual depreciation FORMULA
Accumulated depreciation #VALUE! #VALUE! #VALUE!
Ending Book Value #VALUE! #VALUE! #VALUE! #VALUE!
AAR FORMULA
Scenario 2
Projected
Year Net Income
1 $1,000,000
2 1,200,000
3 1,300,000
4 900,000
Installation cost
Year 1 2 3 4
Beginning BV
Annual depreciation FORMULA
Accumulated depreciation #VALUE! #VALUE! #VALUE!
Ending Book Value #VALUE! #VALUE! #VALUE! #VALUE!
AAR #VALUE!
(Scenario 1)
The initial investment was on 10000000
Page 5
Scenario 2
(Scenario 2)
The net income was projected as follows:
Projected
Year Net Income
1 1000000
2 1200000
3 1300000
4 900000
Page 6
Fundamentals of Corporate Finance
Ross, Westerfield, and Jordan -- Fifth Edition
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A firm evaluates all of its projects by applying the IRR rule. If the required return is 18 percent, should the
firm accept the following project?
Solution
Instructions
Use the Excel IRR function to calculate the Internal Rate of Return on this project.
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A project that provides annual cash flows of $400 for eight years costs $1,500 today. Is this a good project
if the required return is 8 percent? What if it’s 24 percent? At what discount rate would you be indifferent
between accepting the project and rejecting it?
Solution
Instructions
Use the PV function to calculate the NPV of the project at the two required rates of return. Then use
the IRR function to calculate the projects internal rate of return.
8% 24%
Required Required
rate of return rate of return
Net Present Value FORMULA FORMULA
Real Estate Solutions, Inc. has identified the following two mutually exclusive projects:
Year Cash Flow (A) Cash Flow (B)
0 ($11,000) ($11,000)
1 4,000 1,000
2 5,000 6,000
3 6,000 5,000
4 1,000 5,000
a. What is the IRR for each of these projects? If you apply the IRR decision rule, which project should the
company accept? Is this decision necessarily correct?
b. If the required return is 11 percent, what is the NPV for each of these projects? Which project will you
choose if you apply the NPV decision rule?
c. Over what range of discount rates would you choose Project A? Project B? At what discount rate would
you be indifferent between these two projects? Explain.
Solution
Instructions
Use the IRR and NPV functions to solve this problem.
a. What is the IRR for each of these projects? If you apply the IRR decision rule, which project should the
company accept? Is this decision necessarily correct?
Project A Project B
Internal rate of return FORMULA FORMULA
b. If the required return is 11 percent, what is the NPV for each of these projects? Which project will you
choose if you apply the NPV decision rule?
Project A Project B
Net present value FORMULA FORMULA
c. Over what range of discount rates would you choose Project A? Project B? At what discount rate would
you be indifferent between these two projects? Explain.
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What is the profitability index for the following set of cash flows if the relevant discount rate is:
10%
15%
22%
Solution
Instructions
Use the NPV Excel function to calculate the profitability index.
Cash
Year Flow
0 ($1,600)
1 900
2 350
3 300
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An investment has an installed cost of $257,650. The cash flows over the four-year life of the investment are
projected to be:
Sketch the NPV profile for this investment based on these three points.
Solution
Instructions
Use the NPV function to solve the problem.
Discount rate 0%
NPV FORMULA
NPV
At what discount rate is the NPV just equal to zero? (Hint: IRR)
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The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M.
Deep, business is "looking up." As a result, the cemetery project will provide a net cash inflow of $25,000
for the firm during the first year, and the cash flows are projected to grow at a rate of 7 percent per year
forever. The project requires an initial investment of $300,000.
a. If Yourdone requires a 14 percent return on such undertakings, should the cemetery business be
started?
b. The company is somewhat unsure about the assumption of a 7 percent growth rate in its cash flows. At
what constant growth rate would the company just break even if it still required a 14 percent return on
investment?
Solution
Instructions
Enter data and formulas to solve the problem.
a. If Yourdone requires a 16 percent return on such undertakings, should the cemetery business be
started?
Required return
Initial Investment
First year cash flow
Growth rate
b. The company is somewhat unsure about the assumption of a 7 percent growth rate in its cash flows. At
what constant growth rate would the company just break even if it still required a 16 percent return on
investment?