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Time Value of Money / Capital Budgeting

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Text book: Corporate Finance, 8th edition, Ross. Westerfield. Jaffe

Unit 2 Homework
Submit answers, as an attachment, to the following questions to Unit 2 Dropbox. All calculations must be shown. For problems that have an Excel template, be sure to download the template from the publisher's web site, and save as an Excel file.
Chapter 4: Problems 10 (template is available)
Chapter 5: Problem 6 (template is available)
Chapter 6: Problem 13 (template is available)
Chapter 7: Problem 2 (template is available)

Chapter 4 - #10
Continuous Compounding - Compute the future value of $1,000 continuously compounded for:
a. 5 years at a stated annual interest rate of 12 percent
b. 3 years at a stated annual interest rate of 10 percent
c. 10 years at a stated annual interest rate of 5 percent
d. 8 years at a stated annual interest rate of 7 percent

Chapter 5 - #6
Stock Values - Warren Corporation will pay a $3.60 per share dividend next year. The company pledges to increase its dividend by 4.5 percent per year indefinitely. If you require a 13 percent return on your investment, how much will you pay for the company's stock today?

Chapter 6 - #13
NPV versus IRR - Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporate (BRC). Both projects require an annual return of 15 percent.

Year Deepwater fishing New Submarine Ride
0 -$600,000 -$1,800,000
1 270,000 1,000,000
2 350,000 700,000
3 300,000 900,000

As a financial analyst for BRC, you are asked the following questions:
a. If your decision rule is to accept the project with the greater IRR, which project should you choose?
b. Because you are fully aware of the IRR rule's scale problem, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you choose?
c. To be prudent, you compute the NPV for both projects. Which project should you choose? Is it consistent with the incremental IRR rule?

Chapter 7 - #2
Calculating Project NPV - The Best Manufacturing Company is considering a new investment. Financial projections for the investments are tabulated here. The corporate tax rate is 34 percent. Assume all the sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project.

Year 0 Year 1 Year 2 Year 3 Year 4
Investment $10,000 - - - -
Sales Revenue - $7000 $7000 $7000 $7000
Operating Costs - 2000 2000 2000 2000
Depreciation 2500 2500 2500 2500
Net Working Capital spending 200 250 300 200 ?

a. Compute the incremental net income of the investment for each year
b. Compute the incremental cash flows of the investment for each year
c. Suppose the appropriate discount rate is 12 percent. What is the NPV of the project?

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The solution explains some questions relating to time value of money and capital budgeting

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Financial Management Problems

1. Your brother has asked you to help him with choosing an investment. He has $5,000 to invest today for a period of two years. You identify a bank CD that pays an interest rate of 4.25 percent with the interest being paid quarterly. What will be the value of the investment in two years?
A) $5,434
B) $5,441
C) $5,107
D) $5,216

2. Jet, Inc., has net sales of $712,478 and accounts receivables of $167,435. What are the firm's accounts receivables turnover and days' sales outstanding?
A) 0.24 times; 78.5 days
B) 4.26 times; 85.7 days
C) 5.2 times; 61.3 days
D) None of the above

3. If your investment pays the same amount at the beginning of each year for a period of 10 years, the cash flow stream is called
A) a perpetuity.
B) an ordinary annuity.
C) an annuity due.
D) none of the above.

4. If your investment pays the same amount at the end of each year forever, the cash flow stream is called
A) a perpetuity.
B) an ordinary annuity.
C) an annuity due.
D) none of the above.

5. Your investment in a small business venture will produce cash flows that increase by 15 percent every year for the next 25 years. This cash flow stream is called
A) an annuity due.
B) a growing perpetuity.
C) an ordinary annuity.
D) a growing annuity.

6. Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent.

- What is the net present value of this project? (Round to the nearest million dollars.)
A) $10 million
B) $12 million
C) $14 million
D) $16 million

- What is the internal rate of return that Turnbull can earn on this project? (Round to the nearest percent.)
A) 41%
B) 42%
C) 43%
D) 44%

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