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# Several Cash Flow and NPV Problems

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1. (Payback and discounted payback period calculations) The Bar-None Manufacturing Co. manufactures fence panels used in cattle feed lots throughout the Midwest. Bar-None's management is considering three investment projects for next year but doesn't want to make any investment that requires more than three years to recover the firm's initial investment. The cash flows for the three projects (Project A, Project B, and Project C) are as follows:
Year Project A Project B Project C
0 \$(1000) \$(10,000) \$(5,000)
1 600 5,000 1,000
2 300 3,000 1,000
3 200 3,000 2,000
4 100 3,000 2,000
5 500 3,000 2,000

a. Given Bar-None's three-year payback period, which of the projects will qualify for acceptance?
b. Rank the three projects using their payback periods. Which project looks the best using this criterion? Do you agree with this ranking? Why or why not?
c. If Bar-None uses a 10 percent discount rate to analyze projects, what is the discounted payback period for each of the three projects? If the firm still maintains its three-year payback policy for the discounted payback, which projects should the firm undertake?

2. (Net present value calculation) Big Steve's makers of swizzle sticks, is considering the purchase of a new plastic stamping machine. This investment requires an initial outlay of \$100,000 and will generate net cash inflows of \$18,000 per year for 10 years.
a. What is the project's NPV using a discount rate of 10 percent? Should the project be accepted? Why or Why not?
b. What is the project's NPV using a discount rate of 15 percent? Should the project be accepted? Why or why not?
c. What is this project's internal rate of return? Should the project be accepted? Why or why not?

3. (Incremental earnings from advertising synergies) Bangers, Inc. is a start-up manufacturer of Australian-style frozen veggie pies located in San Antonio, Texas. The company is five years old and recently installed the manufacturing capacity to quadruple its unit sales. To jump start the demand for its products, the company founders have hired a local advertising firm to create a series of ads for its new line of meat pies. The ads will cost the firm \$400,000 to run for one year. Boomerang's management hopes that the advertising will produce annual sales of \$2 million for its meat pies. Moreover, the firm's management expects that sales of its veggie pies will increase by \$200,000 next year as a result of the company name recognition derived from the meat pie ad campaign. If Boomerang's operating profits per dollar of new sales revenue are 40 percent and the firm faces a 30 percent tax bracket, what is the incremental operating profit the firm can expect to earn from the ad campaign? Does the decision to place the ad look good from the perspective of the anticipated profits?

4. (Calculating project cash flows and NPV) You are considering expanding your product line that currently consists of skateboards to include gas powered skateboards, and you feel you can sell 10,000 of these per year for 10 years (after which time this project is expected to shut down, with solar-powered skateboards taking over). The gas skateboards would sell for \$100 each with variable costs of \$40 for each one produced, and annual fixed costs associated with production would be \$160,000. In addition, there would be a \$1,000,000 initial expenditure associated with the purchase of new production equipment. It is assumed that this initial expenditure will be depreciated using the simplified straight-line method down to zero over 10 years. The project will also require a one-time initial investment of \$50,000 in net working capital associated with inventory, and this working capital investment will be recovered when the project is shut down. Finally, assume that the firm's marginal tax rate is 34 percent.
a. What is the initial cash outlay associated with this project?
b. What are the annual net cash flows associated with this project for Year 1 through 9?
c. What is the terminal cash flow in Year 10 (that is, what is the free cash flow in Year 10 plus any additional cash flows associated with termination of the project)?
d. What is the project's NPV given a 10 percent required rate of return?

5. (Calculating cash flows-comprehensive problem) The C Corporation, a firm in the 34 percent marginal tax bracket with a 15 percent required rate of return or discount rate, is considering a new project. This project involves the introduction of a new product. This project is expected to last five years and then, because this is somewhat of a fad product, it will be terminated. Given the following information, determine the net cash flows associated with the project, the project's net present value, the profitability index, and the internal rate of return. Apply the appropriate decision criteria.
Cost of new plant and equipment: \$198,000,000
Shipping and installation cost: \$ 2,000,000
Unit Sales:
Year Units Sold
1 1,000,000
2 1,800,000
3 1,800,000
4 1,200,000
5 700,000
Sales price per unit: \$800/unit in Years 1-4, \$600/unit in Year 5
Variable cost per unit: \$400/unit
Annual fixed costs: \$10,000,000
Working capital requirements: There will be an initial working capital requirement of \$2,000,000 just to get production started. For each year, the total investment in net working capital will equal 10 percent of the dollar value of sales for that year. Thus, the investment in working capital will increase during Years 1 through 3, then decrease in Years 4, Finally, all working capital is liquidated at the termination of the project at the end of Year 5.
The depreciation method: Use the simplified straight-line method over five years. It is assumed that the plant and equipment will have no salvage value after five years.

#### Solution Summary

The solution answers the five problems of varying complexity using Excel on the topics of payback and discounted payback period caculations. All formulas are provided in Excel cells. Step by step instructions are given as well which are easy to follow along.

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## Finance: Benson Designs' project; Rank Caradine Corp project's proposed risk

P2. Benson Designs has prepared the following estimates for a long-term project it is considering. The initial investment is \$18,250, and the project is expected to yield after-tax cash inflows of \$4,000 per year for 7 years. The firm has a 10% cost of capital.

a. Determine the net present value (NPV) for the project.
b. Determine the internal rate of return (IRR) for the project.
c. Would you recommend that the firm accept or reject the project? Explain your answer.

P4. Caradine Corp., a media services firm with net earnings of \$3,200,000 in the last year, is considering several projects:

Project Initial Investment Details
A \$ 35,000 Replace existing office furnishings.
B 500,000 Purchase digital film-editing equipment for use with several existing accounts.
C 450,000 Develop proposal to bid for a \$2,000,000 per year 10-year contract with the U.S. Navy, not now an account.
D 685,000 Purchase the exclusive rights to market a quality educational television program in syndication to local markets in the European Union, a part of the firm's existing business activities

The media services business is cyclical and highly competitive. The board of directors has asked you, as chief financial officer, to do the following:

a. Evaluate the risk of each proposed project and rank it low, medium, or high.
b. Comment on why you chose each ranking.

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