# Internal Rate of Return

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1.\$500 today and expect to receive \$ 50,000 in 40 years. Your cost of capital for this (very risk) opportunity is 15%.

A.  What is the IRR? What does the IRR rule say about whether the investment should be undertaken?

B.  What is the NPV? What does the NPV rule suggest?

A.  What is the IRR?

The IRR of this investment opportunity is _________%(round to one decimal place.)

2. You are a real estate agent thinking of placing a sign advertising your services at a local bus stop. The sign will cost \$8,000 and will be posted for one year. You expect that it will generate additional revenue of \$ 1,040 a month. What is the payback period?

The payback period is ________months.(round to two decimal places.)

3. You are considering making a movie. The movie is expected to cost \$10.6 million upfront and take a year to make. After that, it is expected to make \$4.4 million in the year it is released (end of year 2) and \$ 1.9 million for the following four years (end of years 3 through6). What is the payback period of this investment? If you require a payback period of two years, will you make the movies? Does the movie have positive NPV if the cost of capital is 10.5%?

The payback period is __________years. (round up to nearest integer.)

Based on the payback period requirement, would you make this movie?____.(select from the drop-down menu.)

4. AOL is considering two proposals to overhaul its network infrastructure .  They have received two bids. The first bid from Huawei will require a \$ 15 million upfront investment and will generate \$20 million in savings for AOL each year for the next 3 years. The second bid from Cisco requires a \$80 million upfront investment and will generate \$60 million in savings each year for the next 3 years.

A.  What is the IRR for AOL associated with each bid?____

B.  If the cost of capital for each investment is 15%, what is the Net Present Value(NPV) of each bid?_______

Suppose Cisco modifies its bid by offering a lease contract instead. Under the terms of the lease, AOL will pay \$22 million upfront, ad \$35 million per year for the next 3 years. AOL savings will be the same as with Cisco’s original bid.

C.  What is the IRR of the Cisco bid now?____

D.  What is the new NPV?_____

E.   What should AOL do?_____

A. What is the IRR for AOL associated with each bid?  The IRR associated with the first bid from Huawe is _______%.(round to one decimal place.)

5. Natasha’s Flowers, a local florist, purchases fresh flowers each day at the local flower market. The buyer has a budget of \$1,040 per day to spend. Different flowers have different profit margins, and also a maximum amount the shop can sell.

Based on past experience the shop has estimated the following NPV of purchasing each type:

NPV per bunch  Cost per bunch  Max. Bunches

Roses  \$3  \$22  25

Lilies  \$11  \$28  10

Pansies  \$6   \$34  10

Orchids  \$21  \$84  5

What combination of flowers the shop should purchase each day?

(select from the drop-down menus in descending order of their profitability- index values. Round the investment amounts to the nearest integer.)

The combination of flowers the shop should purchase each day  is \$___of_____,\$______ of______, and  \$____of________.

6. Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of its pizza that will be low in cholesterol and contain no trans fats. The firm expects that a sales of the new pizza will be \$18 million per year. While many of these sales will be to new customers, Pisa Pizza estimates that 30% will come from customers who switch to the new, healthier pizza instead of buying the original version

A. Assume customers will spend the same amount on either version. What level of incremental sales is associated with introducing the new pizza?

The incremental sales are\$_ _______million.(round to the nearest integer.)

7. Cellular Access Inc. is a cellular telephone service provider that reported net operating profit after tax(NOPAT) of \$255 million for the most recent fiscal year.  The firm had depreciation expenses of \$130 million, capital expenditures of \$190 million, and no interest expenses. Working capital increased by \$11 million . Calculate the free cash flow for Cellular Access for the most recent fiscal year.

The free cash flow is \$_____ million.( round to the nearest million.)

8. Castle View Games would like to invest in a division to develop software for video games. To evaluate this decision, the firm first attempts to project the working capital needs for the this operation. Its chief financial officer has developed the following estimates( in millions of dollars):

Year1  Year2  Year3  Year4  year5

Cash  7  11  16  16  16

Accounts receivable  19  26  26  25   25

Inventory  6  9  12  14  15

Accounts payable  16  20  25  28   34

Assuming that Castle View currently does not have any working capital invested in this division, calculate the cash flows associated with changes in working capital for the first five years of this investment.(Enter decreases as negative numbers.)

9. Markov Manufacturing recently spent \$16 million to purchase some equipment used in the manufacture of disk drives, The firm expects that this equipment will have a useful life of five years, and its marginal corporate tax rate is 28%. The company plans to use straight-line depreciation.

A.  What is the annual depreciation expense is \$ ______ million.(round to two decimal places.)

10. Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following increment free cash flow projections (in millions of dollars):

Free Cash Flow (\$000,000s)   Y ear0  Year1-9  Year10

Revenues  110.00  110.00

-Manufacturing expenses(other than depreciation)  -36.00  -36.00

-Marketing expenses   -9.00  -9.00

-Depreciation  -14.80  -14.80

_____________________________________________________________________________________

=EBIT   50.20  5020

=Taxes (35%)  17.57  -17.57

=Unlevered net income  32.63  32.63

+Depreciation  14.80  14.80

- Increases in Net Working Capital   -5.00  -5.00

-Capital expenditures  -148.00

+Continuation value  11.00

=Free cash flow   -148.00  42.43  53.43

A.  For this base case scenario, what is the NPV of the plant to manufacture lightweight trucks?

B.  Based on input from the marketing department, Bauer is uncertain about its revenue forecast. In particular, management would like to examine the sensitivity of the  NPV to the revenue assumptions. What is the NPV of this project if revenues are 10% higher than forecast? WHAT IS THE NPV IF REVENUES ARE 10% LOWER THAN FORECAST ?

A. For this base case scenario the NPV is \$ _________ million. (round to two decimal places.)

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