Q1. Your firm is considering a project that will cost $4.510 million up front, generate cash flows of $3.47 million per year for 3 years, and then have a cleanup and shutdown cost of $5.96 million in the fourth year.
a. How many IRRs does this project have?
b. Calculate a modified IRR for this project assuming a discount and compounding rate of 9.8%.
c. Using the MIRR and a cost of capital of 9.8%, would you take the project?
Q2. Fast Track Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $202,400 per year. Once in production, the bike is expected to make $295,413 per year for 10 years. The cash inflows begin at the end of year 7.
For parts a-c, assume the cost of capital is 9.3%.
a. Calculate the NPV of this investment opportunity. Should the company make the investment?
b. Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.
c. How long must development last to change the decision?
For parts d-f, assume the cost of capital is 13.5%.
d. Calculate the NPV of this investment opportunity. Should the company make the investment?
e. How much must this cost of capital estimate deviate to change the decision?
f. How long must development last to change the decision?
Q3. You are getting ready to start a new project that will incur some cleanup and shutdown costs when it is completed. The project costs $5.36 million up front and is expected to generate $1.14 million per year for 10 years and then have some shutdown costs at the end of year 11. Use the MIRR approach to find the maximum shutdown costs you could incur and still meet your cost of capital of 14.9% on this project.
Q4. You are choosing between two projects. The cash flows for the projects are given in the following table ($ million):
|
Project
|
Year 0
|
Year 1
|
Year 2
|
Year 3
|
Year 4
|
|
A
|
-$49
|
$23
|
$22
|
$19
|
$14
|
|
B
|
-$100
|
$21
|
$39
|
$48
|
$60
|
a. What are the IRRs of the two projects?
b. If your discount rate is 4.6%, what are the NPVs of the two projects?
c. Why do IRR and NPV rank the two projects differently?
Q5. 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 10.6%. The company plans to continue with one of the two models for the foreseeable future. Based on the costs of each shown below, which should it choose? (Note: dollar amounts are in thousands.)
|
Model
|
Year 0
|
Year 1
|
Year 2
|
Year 3
|
Year 4
|
Year 5
|
Year 6
|
Year 7
|
|
Old Reliable
|
-$199
|
-$4.2
|
-$4.2
|
-$4.2
|
-$4.2
|
-$4.2
|
-$4.2
|
-$4.2
|
|
Short and Sweet
|
-$102
|
-$2.1
|
-$2.1
|
-$2.1
|
-$2.1
|
|
|
|
Based on the costs of each model, which should it choose? (Select the best choice below.)
A. Gateway Tours should choose Short and Sweet because the NPV of its costs is smaller.
B. Gateway Tours should choose Old Reliable because it lasts longer.
C. Gateway Tours should choose Old Reliable because the equivalent annual annuity of its costs is smaller.
D. Gateway Tours should choose Short and Sweet because the equivalent annual annuity of its costs is smaller.
Q6. Kartman Corporation is evaluating four different real estate investments. Management plans to buy the properties today and sell them three years from today. The annual discount rate for these investments is 14%. The following table summarizes the initial cost and the sale price in three years for each property:
|
|
Cost Today
|
Sale Price in Year 3
|
|
Parkside Acres
|
$550,000
|
$1,050,000
|
|
Real Property Estates
|
980,000
|
1,580,000
|
|
Lost Lake Properties
|
540,000
|
940,000
|
|
Overlook
|
50,000
|
250,000
|
Kartman has a total capital budget of $600,000 to invest in properties. Which properties should it choose?
Q7. Anle Corporation has a current stock price of $19.06 and is expected to pay a dividend of $0.85 in one year. Its expected stock price right after paying that dividend is $20.89.
a. What is Anlets equity cost of capital?
b. How much of Anle's equity cost of capital is expected to be satisfied by dividend yield and how much by capital gain?
Q8. Halliford Corporation expects to have earnings this coming year of $2.908 per share. Halliford plans to retain all of its earnings for the next two years. Then, for the subsequent two years, the firm will retain 54% of its earnings. It will retain 22% of its earnings from that point onward. Each year, retained earnings will be invested in new projects with an expected return of 18.2% per year. Any earnings that are not retained will be paid out as dividends. Assume Halliford's share count remains constant and all earnings growth comes from the investment of retained earnings. If Halliford's equity cost of capital is 11.5%, what price would you estimate for Halliford stock?