Description
Assignment Steps
Resources: Tutorial help on Excel® and Word® functions can be found on the Microsoft®Office website. There are also additional tutorials via the web that offer support for office products.
Complete the following Questions and Problems from each chapter as indicated.
Show all work and analysis.
Prepare in Microsoft® Excel® or Word.
- Ch. 9: Questions 7 & 8 (Questions and Problems section)
- Ch. 10: Questions 3 & 13 (Questions and Problems section)
- Ch. 11: Questions 1 & 7 (Questions and Problems section)
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Chapter 9 - Question 7:
Calculating IRR: A firm evaluates all its projects by applying the IRR rule. If the required
return is 14 percent, should the firm accept the following project?
Year
Cash Flow
0
-$26,000
1
11, 000
2
14,000
3
10,000
Solution:
The internal rate of return (IRR) is defined as the compound rate of return r that makes the
NPV equal to zero:
𝑁
𝐶𝐹0 + ∑
𝑡=1
−26,000 +
𝐶𝐹𝑡
=0
(1 + 𝑟)𝑡
11,000
14,000
10,000
+
+
=0
(1 + 𝑟) (1 + 𝑟)2 (1 + 𝑟)3
From Excel®, the solution is 𝑟 = 17%
∴ 𝑰𝑹𝑹 𝒊𝒔 𝟏𝟕%
Since the IRR (17%) is greater than the required rate of return (14%), the firm should go ahead
and accept the project.
Chapter 9
Question 8
Calculating NPV: For the cash flows in the previous problems, suppose the firm uses the NPV
decision rule. At a required return of 11 percent, should the firm accept this project? What if the
required return is 24 percent?
Solution:
With reference to the table in question 7,
𝑁
𝑁𝑃𝑉 = 𝐶𝐹0 + ∑
𝑡=1
𝐶𝐹𝑡
(1 + 𝑟)𝑡
𝑨𝒕 𝒓 = 𝟏𝟏% = 𝟎. 𝟏𝟏,
𝑁𝑃𝑉 = −26,000 +
11,000
14,000
10,000
+
+
2
(1 + 0.11) (1 + 0.11)
(1 + 0.11)3
𝑁𝑃𝑉 = −26,000 +
11,000 14,000 10,000
+
+
1.11
1.112
1.113
𝑁𝑃𝑉 = −26,000 + 9,909.91 + 11,362.71 + 7,311.91
𝑁𝑃𝑉 = $2,584.54
At a required return rate of 11%, NPV is positive (+$2,584.54), the firm should accept the
project.
𝑨𝒕 𝒓 = 𝟐𝟒% = 𝟎. 𝟐𝟒,
𝑁𝑃𝑉 = −26,000 +
11,000
14,000
10,000
+
+
2
(1 + 0.24) (1 + 0.24)
(1 + 0.24)3
𝑁𝑃𝑉 = −26,000 +
11,000 14,000 10,000
+
+
1.24
1.242
1.243
𝑁𝑃𝑉 = −26,000 + 8,870.97 + 9,105.10 + 5,244.87
𝑁𝑃𝑉 = −$2,799.06
At 24% required return rate, the NPV is a negative value (-$2,799.06). Therefore the firm
should not accept this project
Chapter 10 - Question 3
Calculating Project Net Income: A proposed new investment has projected sales of $635,000.
Variable costs are 44 percent of sales, and fixed costs are $193,000; depreciation is $54,000.
Prepare a pro forma income statement assuming a tax rate of 35 percent. What is the project net
income?
Solution:
Given:
Projected sales = $635,000
Variable costs = 44% of sales = 0.44 × $635,000 = $279,400
Fixed costs = $193,000
Depreciation = $54,000
Tax rate = 35%
Total Expenses: 279,400 + 193,000 + 54,000 = $526,400
Earning Before Interest and Tax (EBIT) = Projected Sales − Total Expenses
Earning Before Interest and Tax (EBIT) = 635,000 − 526,400 = $108,600
Taxes = 35% × EBIT = 0.35 × $108,600 = $38,010
∴ 𝐏𝐫𝐨𝐣𝐞𝐜𝐭 𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞 = 𝐄𝐁𝐈𝐓 − 𝐓𝐚𝐱 = $𝟕𝟎, 𝟓𝟗𝟎
Pro Forma Income Statement
Projected Sales
$635,000
Variable cost
$279,000
Fixed cost
$193,000
Depreciation
$54,000
Total Expenses
$526,400
Earnings Before Interest and Taxes (EBIT)
$108,600
Taxes
$38,010
Net Income
$70,590
The project Net Income is $70,590.
Chapter 10 – Question 13.
Project Evaluation: Dog up! Frank is looking at a new sausage system with an installed cost of
$540,000. This cost will be depreciated straight-line zero over the project’s five-year life, at the
end of which the sausage system can be scrapped for $80,000. The sausage system will save the
firm $170,000 per year in pretax operating costs, and the system requires an initial investment in
net working capital of $29,000. If the tax rate is 34 percent and the discount rate is 10 percent,
what is the NPV of the project?
Solution:
For the new sausage system
Annual depreciation =
$540,000
= $108,000
5
Aftertax salvage value = Market Value + (Book Value − Market Value) × Tax
Market Value = $80,000,
Book Value = $0
Tax = 34%
∴ Aftertax salvage value = MV + (0 − MV) × T = MV − MV ∙ T = 𝐌𝐕(𝟏 − 𝐓)
∴ Aftertax salvage value = $80,000(1 − 0.34) = $52,800
Applying the tax shield approach, the Operating Cash Flow (OCF) for the project is:
𝑂𝐶𝐹 = (𝑆 − 𝐶) × (1 − 𝑇) + 𝐷 × 𝑇
where: 𝑠 = 𝑡𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠,
𝑐 = 𝑐𝑎𝑠ℎ 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠, 𝐷 = 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛, and 𝑇 = 𝑡𝑎𝑥
∴ 𝑂𝐶𝐹 = $170,000(1 − 0.34) + (0.34 × 108,000) = 112,200 + 36720 = $148,920
The NPV f...
