10.

Timing Differences

The Ewert Exploration Company is considering two mutually exclusive plans for extracting oil on property for which it has mineral rights. Both plans call for the expenditure of $11 million to drill development wells. Under Plan A, all the oil will be extracted in 1 year, producing a cash flow at t = 1 of $11.5 million; under Plan B, cash flows will be $1.5 million per year for 20 years.

1. What are the annual incremental cash flows that will be available to Ewert Exploration if it undertakes Plan B rather than Plan A? (Hint: Subtract Plan A's flows from B's.) Enter your answers in millions. For example, an answer of $1.23 million should be entered as 1.23, not 1,230,000. Round your answers to two decimal places. Use a minus sign to enter cash outflows, if any.

   Year	Incremental Cash Flow (B - A)
   1	$ million
   2-20	$ million

2. If the company accepts Plan A and then invests the extra cash generated at the end of Year 1, what rate of return (reinvestment rate) would cause the cash flows from reinvestment to equal the cash flows from Plan B? Round your answer to two decimal places.

   %

3. Suppose a firm's cost of capital is 10%. Is it logical to assume that the firm would take on all available independent projects (of average risk) with returns greater than 10%? Further, if all available projects with returns greater than 10% have been taken, would this mean that cash flows from past investments would have an opportunity cost of only 10% because all the firm could do with these cash flows would be to replace money that has a cost of 10%? Finally, does this imply that the cost of capital is the correct rate to assume for the reinvestment of a project's cash flows?

   I. No, the firm would not take on all available independent projects with greater than 10% returns. If taken, risk remains the same among projects and the cost of capital does not vary with the amount of capital raised. II. Yes, the firm would take on all available independent projects with greater than 10% returns. If taken, risk varies with projects and the cost of capital varies with the amount of capital raised. III. Yes, the firm would take on all available independent projects with greater than 10% returns. If taken, risk remains the same among projects and the cost of capital does not vary with the amount of capital raised.

   -Select----------

4. Select the correct graph for NPV profiles for Plans A and B.

   The correct graph is -Select-----------

   Identify each project's IRR. Round your answers to two decimal places.

   Project A: %

   Project B: %

   Indicate the crossover rate. Round your answer to two decimal places.

   %

11. Unequal Lives

Shao Airlines is considering the purchase of two alternative planes. Plane A has an expected life of 5 years, will cost $100 million, and will produce net cash flows of $30 million per year. Plane B has a life of 10 years, will cost $132 million, and will produce net cash flows of $25 million per year. Shao plans to serve the route for only 10 years. Inflation in operating costs, airplane costs, and fares are expected to be zero, and the company's cost of capital is 12%. By how much would the value of the company increase if it accepted the better project (plane)? Do not round intermediate calculations. Enter your answer in millions. For example, an answer of $1.234 million should be entered as 1.234, not 1,234,000. Round your answer to three decimal places.

$ million

What is the equivalent annual annuity for each plane? Do not round intermediate calculations. Enter your answers in millions. For example, an answer of $1.234 million should be entered as 1.234, not 1,234,000. Round your answers to three decimal places.

Plane A: $ million

Plane B: $ million

12.

Unequal Lives

The Perez Company has the opportunity to invest in one of two mutually exclusive machines that will produce a product it will need for the foreseeable future. Machine A costs $10 million but realizes after-tax inflows of $4 million per year for 4 years. After 4 years, the machine must be replaced. Machine B costs $15 million and realizes after-tax inflows of $3.5 million per year for 8 years, after which it must be replaced. Assume that machine prices are not expected to rise because inflation will be offset by cheaper components used in the machines. The cost of capital is 10%. Using the replacement chain approach to project analysis, by how much would the value of the company increase if it accepted the better machine? Do not round intermediate calculations. Enter your answer in millions. For example, an answer of $1.23 million should be entered as 1.23, not 1,230,000. Round your answer to two decimal places.

$ million

What is the equivalent annual annuity for each machine? Do not round intermediate calculations. Enter your answers in millions. For example, an answer of $1.23 million should be entered as 1.23, not 1,230,000. Round your answers to two decimal places.

Machine A: $ million

Machine B: $ million

13.

Unequal Lives

Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $220,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $97,000 per year; and Machine 360-6, which has a cost of $320,000, a 6-year life, and after-tax cash flows of $93,400 per year. Knitting machine prices are not expected to rise because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that Filkins's cost of capital is 12%.

Calculate the two projects' extended NPVs. Do not round intermediate calculations. Round your answers to the nearest dollar.

Machine 190-3: $

Machine 360-6: $

Should the firm replace its old knitting machine? If so, which new machine should it use?

The firm -------.

By how much would the value of the company increase if it accepted the better machine? Do not round intermediate calculations. Round your answer to the nearest dollar.

$

What is the equivalent annual annuity for each machine? Do not round intermediate calculations. Round your answers to the nearest dollar.

Machine 190-3: $

Machine 360-6: $

15.

Present Value of Costs

The Aubey Coffee Company is evaluating the within-plant distribution system for its new roasting, grinding, and packing plant. The two alternatives are (1) a conveyor system with a high initial cost but low annual operating costs and (2) several forklift trucks, which cost less but have considerably higher operating costs. The decision to construct the plant has already been made, and the choice here will have no effect on the overall revenues of the project. The cost of capital for the plant is 13%, and the projects' expected net costs are listed in the following table:

	Expected Net Cost
Year	Conveyor		Forklift
0	-$500,000		-$200,000
1	-120,000		-160,000
2	-120,000		-160,000
3	-120,000		-160,000
4	-120,000		-160,000
5	-20,000		-160,000

1. What is the IRR of each alternative?

   The IRR of alternative 1 is -Select-undefined 11% 13% 15% Item 1 .

   The IRR of alternative 2 is -Select-undefined 11% 13% 15% Item 2 .

2. What is the present value of costs of each alternative? Do not round intermediate calculations. Round your answers to the nearest dollar. Use a minus sign to enter negative values, if any.

   Alternative 1: $

   Alternative 2: $

   Which method should be chosen?

   -Select-IRR methodPV methodItem 5 should be chosen.

16.

Payback, NPV, and MIRR

Your division is considering two investment projects, each of which requires an up-front expenditure of $23 million. You estimate that the cost of capital is 8% and that the investments will produce the following after-tax cash flows (in millions of dollars):

Year	Project A		Project B
1	5		20
2	10		10
3	15		8
4	20		6

1. What is the regular payback period for each of the projects? Round your answers to two decimal places.

   Project A: years

   Project B: years

2. What is the discounted payback period for each of the projects? Do not round intermediate calculations. Round your answers to two decimal places.

   Project A: years

   Project B: years

3. If the two projects are independent and the cost of capital is 8%, which project or projects should the firm undertake?

   The firm should undertake -Select-Project AProject Bboth projectsItem 5 .

4. If the two projects are mutually exclusive and the cost of capital is 5%, which project should the firm undertake?

   The firm should undertake -Select-Project AProject BItem 6 .

5. If the two projects are mutually exclusive and the cost of capital is 15%, which project should the firm undertake?

   The firm should undertake -Select-Project AProject BItem 7 .

6. What is the crossover rate? Round your answer to two decimal places.

   %

7. If the cost of capital is 8%, what is the modified IRR (MIRR) of each project? Do not round intermediate calculations. Round your answers to two decimal places.

   Project A: %

   Project B: %

17.

Economic Life

The Scampini Supplies Company recently purchased a new delivery truck. The new truck cost $22,500, and it is expected to generate net after-tax operating cash flows, including depreciation, of $6,250 per year. The truck has a 5-year expected life. The expected salvage values after tax adjustments for the truck are given below. The company's cost of capital is 7 percent.

Year	Annual Operating Cash Flow		Salvage Value
0	-$22,500		$22,500
1	6,250		17,500
2	6,250		14,000
3	6,250		11,000
4	6,250		5,000
5	6,250		0

1. What is the optimal number of years to operate the truck? Do not round intermediate calculations. Round your answers to the nearest whole number.

   years

2. Would the introduction of salvage values, in addition to operating cash flows, ever reduce the expected NPV and/or IRR of a project?

   I. Yes. Salvage possibilities could only lower NPV and IRR. II. Salvage possibilities would have no effect on NPV and IRR. III. No. Salvage possibilities could only raise NPV and IRR.

   -Select-IIIIIIItem 2