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# Capital Budgeting- calculating NPV, rate of return, after tax

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Quiz 6
Chpt. 7,8,9 Capital Budgeting

1. You are evaluating purchasing the rights to a project that will generate after tax expected cash flows of \$90,000 at the end of each of the next five years, plus an additional \$1,000,000 at the end of the fifth year as the final cash flow. You can purchase this project for \$950,000. If your firm's cost of capital (aka required rate of return) is 15%, what is the NPV of this project?
a. 500,000
b. 950,000
c. -106,000
d. -151,000
e. insufficient information to estimate an NPV

2. You are evaluating purchasing the rights to a project that will generate after tax expected cash flows of \$90,000 at the end of each of the next five years, plus an additional \$1,000,000 at the end of the fifth year as the final cash flow. You can purchase this project for \$950,000. At this price, what rate of return would you earn on the investment (aka what is the internal rate of return)?
a. 10.3%
b. 7.7%
c. 9.6%
d. 52.6% ((90*5+1000)/950 -1)
e. 15%
f. insufficient information to estimate a return rate

3. If accepting 1 project implies that you can NOT also accept another alternative project, we would say these 2 projects are:
a. mutually exclusive
b. independent
c. profitable
d. synergistic
e. none of the above

4. You are considering the purchase of an investment that would pay you \$5,000 per year for Years 1 5, \$3,000 per year for Years 6 8, and \$2,000 per year for Years 9 and 10. If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then what is the MOST you would be willing to pay for this investment?
a. \$15,819.27
b. \$21,937.26
c. \$32,415.85
d. \$38,000.00
e. \$52,815.71

5. When evaluating whether to proceed with a project, the firm should consider all of the following factors EXCEPT which one? (i.e., Which is a "not relevant" versus " relevant" cash flow?)
a. changes in working capital attributable to the project
c. the current market value of any equipment to be sold and replaced
d. the resulting difference in depreciation if the project involves a replacement decision
e. all of the above should be considered.

6. While doing a capital budgeting analysis you realized that the project would require an increase in inventory of \$8000. You should
a. ignore the inventory requirement because it is not an operating cash flow
b. record the \$8000 at time zero as an additional benefit of taking the project
c. remember to depreciate the \$8000 over the depreciable life of the project
d. record the \$8000 at time zero as an additional cost of taking the project
e. none of the above are accurate

7. Royal Dutch Petro (RDP) is considering a new equipment purchase that would replace some existing equipment. The old equipment has a Book Value (BV) of \$400 thousand and RDP estimates that the equipment could be sold for ONLY \$150 thousand. What is the After Tax Salvage Value (ATSV) of the old equipment that RDP should use in their capital budgeting analysis? Assume the tax rate = T= 35%.
a. 0, since the sale of old equipment has nothing to do with analysis of new equipment being purchased
b. 87.5 thousand
c. 62.5 thousand
d. -250 thousand
e. 237.5 thousand

8. All of the following are common cash flow items to be considered at TIME ZERO, except
a. initial purchase costs of assets
b. net cashflow from sale of any old equipment being replaced
c. installation costs
d. working capital investment (such as inventory)
e. depreciation tax shield from new assets being purchased

9. If you earn a 10% nominal return on an investment, are you really 10% more wealthy?
b. No, because if inflation = 0, then your real return is less
c. Yes, because you really have 10% more dollars
d. Yes, because inflation does NOT effect your real wealth
e. Yes, because nominal returns are the returns widely published & quoted in the press

10. Which of the following terms addresses the problem when introducing a new product line could steal sales away from an existing product line?
a. Enhancement
b. Cannibalization
c. Payback
d. Discounting
e. None of the above

#### Solution Preview

Answers are below. Explanations are *ATTACHED*

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1. You are evaluating purchasing the rights to a project that will generate after tax expected cash flows of \$90,000 at the end of each of the next five years, plus an additional \$1,000,000 at the end of the fifth year as the final cash flow. You can purchase this project for \$950,000. If your firm's cost of capital (aka required rate of return) is 15%, what is the NPV of this project?
a. 500,000
b. 950,000
c. -106,000
d. -151,000
e. insufficient information to estimate an NPV

NPV is calculated by finding the present value of each cash flow, including both cash inflows and outflows, discounted at the project's cost of capital.

NPV = sum of CFt where CF is the cash flow
(1 + k)t k is the required return
t is the period

0%

NPV = - 950,000 + 90,000 + 90,000 + 90,000 + 90,000 + 1,090,000
(1.15)1 (1.15)2 (1.15)3 (1.15)4 (1.15)5

NPV = - \$151,000

2. You are evaluating purchasing the rights to a project that will generate after tax expected cash flows of \$90,000 at the end of each of the next five years, plus an additional \$1,000,000 at the end of the fifth year as the final cash flow. You can purchase this project for \$950,000. At this price, what rate of return would you earn on the investment (aka what is the internal rate of return)?
a. 10.3%
b. 7.7%
c. 9.6%
d. 52.6% ((90*5+1000)/950 -1)
e. 15%
f. insufficient information to ...

#### Solution Summary

This solution is comprised of a detailed explanation to answer what is the NPV of this project.

\$2.19