Practice Questions

1-You have an opportunity to invest $49,500 now in return for $60,500 in one year. If your cost of capital is 7.6%,

what is the NPV of this investment? The NPV will be  (Round to the nearest cent.)

2- Your storage firm has been offered $96,500 in one year to store some goods for one year. Assume your costs are $97,000, payable immediately, and the cost of capital is 8.7%. Should you take the contract? The NPV will be  (Round to the nearest cent.)

3-Marian Plunket owns her own business and is considering an investment. If she undertakes the investment, it will pay $4,120 at the end of each of the next 3 years. The opportunity requires an initial investment of $1,030 plus an additional investment at the end of the second year of $5,150. What is the NPV of this opportunity if the interest rate is 2.1% per year? Should Marian take it?What is the NPV of this opportunity if the interest rate is 2.1% per year? The NPV of this opportunity is

4- Your factory has been offered a contract to produce a part for a new printer. The contract would last for 3 years and your cash flows from the contract would be $5.09 million per year. Your upfront setup costs to be ready to produce the part would be $8.02 million. Your discount rate for this contract is 7.6%.

a. What does the NPV rule say you should do? If the value of NPV is positive, then the project should be accepted. The NPV of the project is 

b. If you take the contract, what will be the change in the value of your firm? The value of the firm will increase by

5-Bill Clinton reportedly was paid $15.0 million to write his book My Life. The book took three years to write. In the time he spent writing, Clinton could have been paid to make speeches. Given his popularity, assume that he could earn

$8.9 million per year (paid at the end of the year) speaking instead of writing. Assume his cost of capital is 9.6% per year.

a. What is the NPV of agreeing to write the book (ignoring any royalty payments)? Is – (Round to the nearest dollar.)

b. Assume that, once the book is finished, it is expected to generate royalties of $4.5 million in the first year (paid at the end of the year), and these royalties are expected to decrease at a rate of 30% per year in perpetuity. What is the NPV of the book with the royalty payments? $

6-You are a real estate agent thinking of placing a sign advertising your services at a local bus stop. The sign will cost $4,200

and will be posted for one year. You expect that it will generate additional revenue of $630 a month. What is the payback period? The payback period is  months. (Round to one decimal place.)

7-Professor Wendy Smith has been offered the following opportunity: A law firm would like to retain her for an upfront payment of $50,000. In return, for the next year the firm would have access to eight hours of her time every month. As an alternative payment arrangement, the firm would pay Professor Smith’s hourly rate for the eight hours each month. Smith’s rate is $550

per hour and her opportunity cost of capital is15% per year. What does the IRR rule advise regarding the payment arrangement? (Hint: Find the monthly rate that will yield an effective annual rate of 15%.)

What about the NPV rule? If the value of NPV is positive, then the project should be accepted. If it is negative, then the project is rejected. In this case, the NPV =

The annual IRR is . (Round to two decimal places.)

8-You have just been offered a contract worth $1.22 million per year for 5 years. However, to take the contract, you will need to purchase some new equipment. Your discount rate for this project is 12.1%. You are still negotiating the purchase price of the equipment. What is the most you can pay for the equipment and still have a positive NPV?

The most you can pay for the equipment and achieve the 12.1% annual return is

—- million. (Round to two decimal places.)

9-You are considering making a movie. The movie is expected to cost $10.3 million up front and take a year to produce. After that, it is expected to make $4.4 million in the year it is released and $1.7 million for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have positive NPV if the cost of capital is 10.2%?

What is the payback period of this investment?

The payback period is  years. (Round to one decimal place.)

If required payback period is  years, we will not make the movie.

No, the movie has negative NPV of  million at a cost of capital of %

10- You are choosing between two projects. The cash flows for the projects are given in the following table ($ million):

.

a. What are the IRRs of the two projects? (Round to one decimal place.)

IRR of A		2
IRR of B

b. If your discount rate is 4.5%, what are the NPVs of the two projects?

NPV of A
NPV of B

c. Why do IRR and NPV rank the two projects differently?

Both of them employ different reinvestment rates, which results in different rankings for each. Additionally, the total amounts of the cashflows are not the same.

11-You need a particular piece of equipment for your production process. An equipment-leasing company has offered to lease the equipment to you for $10,500 per year if you sign a guaranteed 5-year lease (the lease is paid at the end of each year). The company would also maintain the equipment for you as part of the lease. Alternatively, you could buy and maintain the equipment yourself. The cash flows from doing so are listed here: (the equipment has an economic life of 5 years). If your discount rate is 7.3%, what should you do?

The net present value of the leasing alternative is $  (Round to the nearest dollar.)

Leasing (-42708) seems to be a better option than buying ($) the equipment because it has a lower NPV value.

12-Gateway Tours is choosing between two bus models. One is more expensive to purchase and maintain but lasts much longer than the other. Gateway’s discount rate is 11.1%.

The company plans to continue with one of the two models for the foreseeable future. Based on the costs of each shown here:

, which should it choose? (Note: dollar amounts are in thousands.)

Based on the costs of each model, which should it choose?(Select the best choice below.)

A.Gateway Tours should choose Old Reliable because the equivalent annual annuity of its costs is smaller.

B. Gateway Tours should choose Short and Sweet because the equivalent annual annuity of its costs is smaller.

C. Gateway Tours should choose Old Reliable because it lasts longer

D. Gateway Tours should choose Short and Sweet because the NPV of its costs is smaller.

13- Fabulous Fabricators needs to decide how to allocate space in its production facility this year. It is considering the following contracts: LOADING…

.a. What are the profitability indexes of the projects? (Round to two decimal places.)

Contract	Profitability indices
A
B
C

b. What should Fabulous Fabricators do?

Fabulous Fabricators should invest in Projects B and C because they have a sum  NPV of 1.98 + 3.23 = 5.17, an NPV that is  higher than that of Project A.

14-Orchid Biotech Company is evaluating several different development projects for experimental drugs. Although the cash flows are difficult to forecast, the company has come up with the following estimates of the initial capital requirements and NPVs for the projects: Given a wide variety of staffing needs, the company has also estimated the number of research scientists required for each development project (all cost values are given in millions of dollars).

a. Suppose that Orchid has a total capital budget of $60 million. How should it prioritize these projects? (Round to two decimal places)

b. Suppose that Orchid currently has 12 research scientists and does not anticipate being able to hire more in the near future. How should Orchid prioritize these projects?