CH 9 Questions

9.1 A. What is capital investment analysis? Why are capital investment decisions so important to businesses?

b. What is the purpose of placing capital investments into categories, such as mandatory replacement, or expansion of existing products, services, or markets?

c. Should financial analysis play the dominant role in capital investment decisions? Explain your answer.

d. What are the four steps of capital investment financial analysis?

9.3 Describe the following project breakeven and probability measures. Be sure to include each measure?s economic interpretation.

a. Payback

b. Net present value (NPV)

c. Internal rate of return (IRR)

9.5 What is a post-audit? Why is the post-audit critical to good investment decision making?

CH9 Problems

9.1 Find the following value for a single cash flow:

a. The future value of $500 invested at 8 percent for one year

b. The future value of $500 invested at 8 percent for five years

c. The present value of $500 to be received in one year when the opportunity cost rate is 8 percent

9.3 Consider another set of net cash flows:

Year Cash Flow

0 $2,000

1 2,000

2 0

3 1,500

4 2,500

5 4,000

• What is the net present value of the stream if the opportunity cost of capital is 10 percent
• What is the value of the stream at the end of year 5 if the cash flows are invested in an account that pays 10 percent annually?
• What cash flow today (year 0), in lieu of the $2,000 cash flow, would be needed to accumulate $20,000 at the end of year 5? (Assume that the cash flow for years 1 through 5 remain the same.)

9.5Capital Healthplans Inc. is evaluating two different methods for providing home health services to its members. Both methods involve contracting out for services, and the health outcomes and revenues are not affected by the method chosen. Therefore, the net cash flows for the decision are all outflows. Here are the projected flows:

Year Method A Method B

0 ($300,000) ($120,000)

1 (66,000) (96,000)

2 (66,000) (96,000)

3 (66,000) (96,000)

4 (66,000) (96,000)

5 (66,000) (96,000)

• What is each alternative?s IRR?
• If the opportunity cost of capital for both methods is 9 percent, which method should be chosen why?

9.7 The director of capital budgeting for Big sky Health Systems INC. has estimated the following cash flows (in thousands of dollars) for proposed new service:

Year Expected Net Cash Flow

0 ($100)

1 70

2 50

3 20

The projects opportunity cost of capital is 10 percent.

• What is the project?s payback period?
• What is the project?s NPV?
• What is the project?s IRR?

CH 9 Questions 9.1 A. What is capital investment analysis? Why are capital investment decisions so important to businesses? b. What is the purpose of placing capital investments into categories, such as mandatory replacement, or expansion of existing products, services, or markets? c. Should financial analysis play the dominant role in capital investment decisions? Explain your answer. d. What are the four steps of capital investment financial analysis? 9.3 Describe the following project breakeven and probability measures. Be sure to include each measure's economic interpretation. a. Payback b. Net present value (NPV) c. Internal rate of return (IRR) 9.5 What is a post-audit? Why is the post-audit critical to good investment decision making? CH9 Problems 9.1 Find the following value for a single cash flow: a. The future value of $500 invested at 8 percent for one year b. The future value of $500 invested at 8 percent for five years c. The present value of $500 to be received in one year when the opportunity cost rate is 8 percent 9.3 Consider another set of net cash flows: Year Cash Flow 0 $2,000 1 2,000 2 0 3 1,500 4 2,500 5 4,000 A. What is the net present value of the stream if the opportunity cost of capital is 10 percent B. What is the value of the stream at the end of year 5 if the cash flows are invested in an account that pays 10 percent annually? C. What cash flow today (year 0), in lieu of the $2,000 cash flow, would be needed to accumulate $20,000 at the end of year 5? (Assume that the cash flow for years 1 through 5 remain the same.) 9.5Capital Healthplans Inc. is evaluating two different methods for providing home health services to its members. Both methods involve contracting out for services, and the health outcomes and revenues are not affected by the method chosen. Therefore, the net cash flows for the decision are all outflows. Here are the projected flows: Year Method A Method B 0 ($300,000) ($120,000) 1 (66,000) (96,000) 2 (66,000) (96,000) 3 (66,000) (96,000) 4 (66,000) (96,000) 5 (66,000) (96,000) a. What is each alternative's IRR? b. why? If the opportunity cost of capital for both methods is 9 percent, which method should be chosen 9.7 The director of capital budgeting for Big sky Health Systems INC. has estimated the following cash flows (in thousands of dollars) for proposed new service: Year Expected Net Cash Flow 0 ($100) 1 70 2 50 3 20 The projects opportunity cost of capital is 10 percent. a. What is the project's payback period? b. What is the project's NPV? c. What is the project's IRR