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Chapter 10 Questions Question #1Define "mutual exclusivity," and describe ways in which projects can be mutually exclusive. Question #2Capital budgeting is based on the idea of identifying incremental cash flows, so overheads aren't generally included. Does this practice create a problem for a firm which, over a long period of time, takes on a large number of projects that are just barelty acceptable under capital budgeting rules. Question #3Relate the idea of cost of capital to the opportunity cost concept (pages 233-234). Is the cost of capital the opportunity cost of project money? Question #7Suppose the present value of cash ins and cash outs is very close to balanced for a project to build a new $50 million dollar factory, so that the NPV is $25,000. The same company is thinking about buying a new trailer truck for $150,000. The NPV of projected cash flows associated with the truck is also about $25,000. Does this mean that the two projects are comparable? Is one more desirable than the other? If the cash flows have similar risks, are the projects equally risky? Problems Problem #6 Calculate an IRR for the project in problem 2 using an iterative technique. Problem #12Project Alpha requires an initial outlay of $35,000 and results in a single cash inflow of $56,367.50 after five years. a. If the cost of capital is 8%, what are Alpha's NPV and PI? Is the Project acceptable under each of these techniques? b. What is the project Alpha's IRR? Is it acceptable under iRR? c. What are Alpha's NPV and PI if the cost of capital is 12%? Is the project acceptable under that condition? d. What is Alpha's payback period? Does packback make much sense for a project like Alpha? Why or Why not? Problem #15Island Airlines, Inc needs to replace a short-haul commuter plane on one of its busier routes. Two aircraft are on the market that satisfy the general requirements of the route. One is more expensive than the other but has better fuel efficiency and load-bearing characteristics, which result in better long-term profitability. The useful life of both planes is expected to be about seven years, after which time both are assumed to have no value. Cash flow projections for the two aircraft follow: Low Cost High Cost Initial Cost$775,000$950,000 Cash inflows, years 1 through 7 154,000176,275 a. Calculate the payback period for each plane and select the best choice. b. Calculate the IRR for each plane and select the best option. Use the fact that all the inflows can be represented by an annuity. c. Compare the results of parts (a) and (b). Both should select the sam option, but does one method result in a clearer choice than the other based on the relative sizes of the two packback periods vs the relative sizes of two IRRs. d. Calculate the NPV and PI of each project assuming a cost of capital of 6%. Use annuity methods. Which plane is selected by NPV? By PI e. Calculate the NPV and PI of each project assuming the following costs of capital: 2%, 4%, 6%, 8%, and 10%. Use annuity methods. Is the same plane selected by NPV and PI at every level of cost of capital? Investigate the relative attractiveness of the two planes for each method. f. Use the results of parts (b) and (e) to sketch the NPV profiles of the two proposed planes on the same set of axes. Show the IRRs on the graph. Would NPV and IRR ever give conflicting results? Why? Problem #16Bagel Pantry Inc. is considering two mutually exclusive projects with widely differing lives. The company's cost of capital is 12%. The project cash flows are summarized as follows: Project A Project B ($25,000)($23,000) 14,7426,641 14,7426,641 14,7426,641 6,641 6,641 6,641 6,641 6,641 6,641 a. Compare the projects using payback b. Compare the projects using NPV c. Compare the projects using IRR d. Compare the projects using the replacement chain approach. e. Compare the projects using EAA method. f. Choose a project and justify your choice. Problem #25Cassidy and Sons is reviewing a project with an initial cash outflow of $250,000. An additional $100,000 will have to be invested after the first year, followed by an additional investment of $50,000 at the end of the second year. Beginning at the end of the year 3, the project is expected to generate cash flows of $90,000 per year for the next eight years. a. Calculate the project's payback period, IRR, and its NPV and PI at a cost of capital of 8%. b. What concerns might Cassidy have regarding this project beyond the financial calculations from part (a). Chapter 11 Questions Question #1The typical cash flow pattern for business projects involves cash outflows first, and then inflows. However, it's possible to imagine a project in which the pattern is reversed. For example, we might receive a inflows now in return for guaranteeing to make payments later. Would the payback, NPV, and IRR methods give conflicting results? Problems Problem #7Voxland Industries purchased a computer for $10,000, which it will depreciate a straight-line over five years to a $1,000 salvage value. The Computer will then be sold at that price. The Company's At the end of the depreciation life, a net book value remains that is equal to the salvage value.) Problem #8 Resolve the precious problem assuming voxland uses the five year Modified Accelerated Cost Recovery System (MACRS) with no salvage to depreciate the computer. Continue to assume the machine is sold after five years for $1,000. (Hint: Apply the MACRS rules for computers on pages 495-496 to the entire cost of the computer. Notice however that there will be a positive net book value after five years because MACRS takes five years of depreciation over six years due to half-year convention.) Problem #9 Shelton Pharmeauciticals Inc. is planning to develop and introduce a new drug for pain relief. Management expects to sell 3 million units in the first year at $8.50 each and anticipates 10% growth in sales per year thereafter. Operating costs are estimated 70% of revenues. Shelton will invest $20 million in depreciable equipment to develop and produce this product. The equipment will be depreciated straight-line over 15 years to a salvage value of $2.0 million. Shelton's marginal tax-rate is 40%. Calculate the project's operating cash flow in its third year.