Chapter 8 - Investment Decision Rules OVO 1) Mary Fleck owns her own business and considers an investment. If she undertakes the investment, it will pay $5,000 at the end of each of the next three years. The opportunity requires an initial investment of $1,200 plus an additional investment at the end of the second year of $4,000. What is the NPV of this opportunity if the expected rate of return is 2% per year? Should Mary take it? worto wandelt 2) You run a construction firm. You have just won a contract to build a government office building. Building it will require an investment of $10 million today and $5 million in one year. The government will pay you $20 million in one year upon the building's completion. Assume the investors' expected rate of return is 10%. a. What is the NPV of this opportunity? b. How can your firm turn this NPV into cash today? 3) You are considering the following projects (cash flows for project A and B are shown in table below) and can take only one. Your cost of capital is 5%. od A -50 20 40 3 20 50 -100 60 buone a. What are the IRRs of the two projects? b. What are the NPVs of the two projects? c. At what cost of capital are you indifferent between the two projects? 4 You are evaluating a project that will cost $500,000, but is expected to produce cash flows of $125,000 per year for 10 years, with the first cash flow in one year. Your cost of capital is 11% and your company's preferred payback period is three years of less. a. What is the payback period of this project? b. Should you take the project if you want to increase the value of the company? 5) FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six vears and the cost is $200.000 per year. Once, in production, the bike is expected to make $300,000 per year for 10 years. The cash inflows begin at the end of year. Assume the cost of capital is 10%. What is the NPV of this investment opportunity? Should the company make the investment? bol brasnode 6) Your factory has offered a contract to produce a part for a new printer. The contract would be for three years and your cash flows from the contract would be $5 million per year. Your up- front setup costs to be ready to produce the part would be $8 million. Your cost of capital for this contract is 8%. a. What does the NPV rule say you should do? b. If you take the contract, what will be the change in the value of your firm? C. Does the IRR rule agree with the NPV rule? 7) Gateway tours is choosing between two bus models. One is more expensive to purchase and maintain, but lasts much longer than the other. Its discount rate is 11%. It plans to continue with one of the two models for the foreseeable future. Based on the costs of each model shown below, which should it choose? to val 1 2 3 4 5 - 4 4 4 4 - Old Reliable: Short and Sweet: -200 -100 4 -2 -2 9
