Question 1(evaluating investment projects)

Generic Motors Corporation is planning to invest $175,000in year zero (today) in new equipment. This investment is expected to generate net cash flows of $70,000a year for the next 4 years (years 1-4). The salvage value after 4 years is zero. The discount rate (cost of capital) is 20% a year.

Required:

a) What is the net present value (NPV) of this project?

NPV = $

Should the firm invest, based on NPV? (1=yes, 2=no)

b) What is the payback period for this project?

payback period =years

c) What is the modified payback period for this project?

between 1 and 2 yearsbetween 2 and 3 yearsbetween 3 and 4 years

d) What is the accounting rate of return (ARR) for this project?

To compute ARR, first compute:

annual depreciation=$

annual income=$

average investment=$

ARR =%(enter say 10% as 10, not as 0.1 and not as 10%)

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Question 2(evaluating investment projects)

General Motors (or Toyota) is thinking of investing in new production equipment, which will cost $200million in year zero, and will generate cost savings of $120million in year 1, $80million in year 2, and $60million in year 3. After 3 years, the salvage value is zero. The cost of capital (discount rate) is 25% for General Motors and 10% for Toyota. (Due to GM's recent bankruptcy, investors are scared to lend it money, so GM has to pay much higher interest rates to attract capital).

Required:

a) What's the NPV of this project for General Motors?

NPV = $million(If you get say $3.52 million, enter 3.52 not 3,520,000. If you get a negative number, enter it with a minus sign, i.e., -3.52 not (3.52))

Should GM invest, based on NPV? (1=yes, 2=no)

b) What's the NPV of this project for Toyota?

NPV = $million

Should Toyota invest, based on NPV? (1=yes, 2=no)

c) If you computed (a) and (b) correctly, the decisions for GM and Toyota should be different. Briefly explain why they are different.

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Question 3

When we evaluate investment projects,

a) do we prefer higher or lower NPV?

(1=higher, 2=lower)

b) do we prefer higher or lower IRR?

(1=higher, 2=lower)

c) do we prefer higher or lower payback period?

(1=higher, 2=lower)

d) do we prefer higher or lower modified payback period?

(1=higher, 2=lower)

e) do we prefer higher or lower ARR?

(1=higher, 2=lower)