Exam
Name___________________________________
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
Answer the question.
1)
As part of a broad effort to invigorate its pipeline and move more aggressively into
biotechnology, GoodDrugs Inc. plans to set up a new division dedicated to developing
biotherapeutic drugs and research technologies. The company expects to pay $240 million
for set up costs of its new division now and $12 million in operating costs each year for the
next 13 years. The company estimates that the new division will be able to generate annual
revenue of $84 million 8 years from now. What is the net present worth of this investment
if the company‘s minimum attractive rate of return is 7% per year and the study period is
13 years? Assume there is no salvage value.
1)
Answer:
–$90,972,037.80
Explanation:
PW = – 240,000,000 –12,000,000 (P/A, 7%, 13) +84,000,000 (P/A, 7%, 6)(P/F,7%,
7)
= – 240,000,000 –100,292,400.00 +249,320,362.20
= – 90,972,037.80
2)
Longhorn Energy is planning a $340 million expansion of two major pipelines in Texas.
The Austin–based pipeline company will add 56 miles of 36–inch pipeline and 20,000
horsepower of compression. The expansion will increase the capacity of the Katy pipeline
in southeast Texas to more than 1.1 billion cubic feet per day from 700,000 million cubic
feet per day. Net revenue per cubic foot is $1.25 and the pipeline is expected to have a
resale value of 28 million at the end of year 38. Determine the capital recovery cost of this
investment if the minimum attractive rate of return is 14% per year.
2)
Answer:
$47,912,000.00
Explanation:
CR = I (A/P, i%, n) – S (A/F, i%, n)
=340,000,000 (A/P, 14%, 38) –28,000,000 (A/F, 14%, 38)
=47,940,000.00 –28,000.00
=47,912,000.00
3)
The cost of building the RAMA IX suspension bridge in Thailand is $8 million. The bridge
will need to be repainted every 7 years and resurfaced every 9 years, each for an indefinite
period of time. The cost of painting is expected to be $159,000 and the cost of resurfacing is
estimated to be $417,000. Determine the capitalized worth of the bridge at an interest rate
of 4% per year.
3)
Answer:
–$9,488,397.50
Explanation:
CW (4%) = – 8,000,000 –159,000 [(A/F, 4%, 7)]/0.04 –417,000 [(A/F, 4%, 9)]/0.04
= – 8,000,000 –159,000 (0.1266)/0.04 –417,000 (0.0945)/0.04
= – 9,488,397.50
4)
Sun Devil Inc. is building two small additions onto its corporate headquarters in Tempe in
order to maximize its operating efficiency. The additions, which total 27,000 square feet,
will attach to the east and south sides of its existing 66,000–square–foot headquarters. The
construction costs are estimated to be $40 per square feet. The company estimates $60,000
per year in fixed costs (e.g., maintenance and insurance, etc.) and $3 per square foot in
variable costs (e.g., utilities, etc.) for the additional facility. The market value of the
additions is expected to be 33% of the construction costs at the end of 20 years. Determine
the capital recovery cost and the EUAC of the two additions if the minimum attractive rate
of return is 4% per year.
4)
Answer:
CR =$67,512.96
EUAC =$208,512.96
Explanation:
I = $(27,000)(40) =1,080,000
S = $(1,080,000)(0.33) =356,400
CR = I (A/P, i%, n) – S (A/F, i%, n)
=1,080,000 (A/P, 4%, 20) –356,400 (A/F, 4%, 20)
=1,080,000 (0.0736) –356,400 (0.0336)
=79,488.00 –11,975.04
=67,512.96
EUAC = CR +60,000 + (3)(27,000)
=208,512.96
5)
A textile manufacturer plans to improve revenue from its heating blankets, sold primarily
in the northern areas of the United States by increasing its marketing activities. A total of
$170,000 spent now in marketing is expected to generate new revenue of $400,000 per year.
The MARR is 6% per year and the evaluation period is 9 years. Use simple payback
analysis to determine the acceptability of the marketing investment.
5)
Answer:
1 year(s)
Explanation:
Simple payback analysis ignores time value of money.
Let N = simple payback period
170,000 = (400,000)(N)
N =170,000/400,000 =1
6)
BioPharm Inc. recently acquired Cow Biopharmaceuticals Inc., a producer of antibodies
and Cow–HB to prevent Hepatitis B re–infection in liver transplant patients. The company
plans to invest $3.5 million in new manufacturing equipment. The Cow Biologics division
is expected to generate revenue of $300,000 and operating cost of $330,000 each month.
The new equipment is estimated to have a $700,000 salvage value after 7 years. What is the
future worth of this investment if the company’s minimum attractive rate of return is 18%
per year, compounded monthly.
6)
Answer:
–$16,509,278.00
Explanation:
Effective interest rate =0.18/12 =0.015 or 1.50% per month
FW = – 3,500,000 (F/P, 1.50%, 84) –330,000 (F/A, 1.50%, 84) +300,000 (F/A, 1.50%,
84) +700,000
= – 3,500,000 (3.4926) – 30,000 (166.1726) +700,000
= – 16,509,278.00
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7)
Husker Co., a major drug store chain, plans to spend $35 million in capital investments for
its new inventory loss reduction initiative. By upgrading the current inventory tracking
system using advanced RFID technology, the company estimates the annual maintenance
cost of $210,000. The salvage value of the system at the end of year 13 is expected to be
0.4% of the original investment. What is the minimum annual inventory loss prevention
required to make this investment economically acceptable if the company’s minimum
attractive rate of return is 8% per year.
7)
Answer:
$4,630,990.00
Explanation:
To make this investment economically acceptable, the annual inventory loss
prevention (A) must be as great as the annual equivalent of the costs.
A =35,000,000 (A/P, 8%, 13) +210,000 –140,000 (A/F, 8%, 13)
=35,000,000 (0.1265) +210,000 –140,000 (0.0465)
=$4,630,990.00
8)
Kenny Pipe & Supply Inc., a wholesale distributor of plumbing supplies, pipe, valves, and
fittings, plans to remodel its existing facility in the Birmingham, Alabama, location. The
facility will require an initial remodeling cost of $370,000 and a monthly operating and
maintenance cost of $30,000. It will have a $66,500 salvage value after 7 years. What is the
net present worth of this investment if the company’s minimum attractive rate of return is
6% per year, compounded monthly?
8)
Answer:
–$2,379,852.95
Explanation:
Effective interest rate =0.06/12 =0.0050 or 0.50%
PW = – 370,000 –30,000 (P/A, 0.50%, 84) +66,500 (P/F, 0.50%, 84)
= – 370,000 –30,000 (68.453) +66,500 (0.6577)
= – 2,379,852.95
9)
GoBulls Media is considering opening a new manufacturing facility to process and mail
coupons to 660,000 households in the Tampa Bay area. The new facility will require an
initial investment of $240,000 and an annual operating cost of $22,000. It will have a
$86,500 salvage value after 5 years. Calculate the net present worth of this investment if
the company’s minimum attractive rate of return is 5% per year, compounded monthly.
9)
Answer:
–$267,542.25
Explanation:
Effective interest rate =(1 +r/M)M– 1 =(1+0.05/12)12 –1
=0.0512 or 5.12%
PW = – 240,000 –22,000 (P/A, 5.12%, 5) +86,500 (P/F, 5.12%, 5)
= – 240,000 –22,000 (4.3152) +86,500 (0.7791)
= – 267,542.25
10)
HighJump Inc. is considering partnering with FieldFeet to open “Athlete Heaven” stores in
the United States as it seeks to expand its own retail network to better control how its
products are displayed and sold. One particular store will require an initial investment of
$220,000 and an annual operating cost of $59,000. The buildings and equipment will have a
$62,500 resale value after 10 years. HighJump expects the store to generate annual revenue
of $69,000. Calculate the future worth of the investment in this particular store at the end
of year 10, and determine the acceptability of the investment if the company’s minimum
attractive rate of return is 8% per year.
Answer:
The future worth is –$267,592.00, which is less than zero; therefore, the investment
should be rejected.
Explanation:
FW = – 220,000 (F/P, 8%, 10) –59,000 (F/A, 8%, 10) +69,000 (F/A, 8%, 10) +62,500
= – 220,000 (2.1589) + 10,000 (14.4866) +62,500
= – 267,592.00
The future worth is less than zero; therefore, the investment should be rejected.
11)
A new water treatment operation is being considered for the new automated water
treatment plant in South Africa. The system can be purchased and installed for $44.5
million and requires additional annual operating and maintenance expenses of $2.7
million over a 22–year period. However, it will save an estimated $5.7 million each year
from the reduced operational, environmental, and security risks. The company uses a
MARR of 12 percent per year in its economic evaluations of the new system. The market
value of the system will be $4.45 million at the end of 22 years. Write the correct equation
to determine if this system should be installed using the IRR method.
Answer:
PW = 0 = – 44.5 + (–2.7 +5.7)(P/A, i*%, 22) +4.45 (P/F, i*%, 22)
Explanation:
Also, AW = 0 = – 44.5 (A/P, i*%, 22) –2.7 +5.7 +4.45 (A/F, i*%, 22)
If i*% 12%, the system should be installed.
12)
Oregon Ducks, Inc. is considering buying licenses for 12 megahertz of wireless spectrum in
the 700 MHz range, which is suitable for delivering television to mobile phones. The 700
MHz signals can travel long distances and more easily penetrate walls and other obstacles.
The acquisition cost is $250 million. In addition, because networks that operate in the 700
MHz range are less expensive to build than those in other portions of the spectrum, Ducks
estimates annual costs of $25 million over the next 7 years and no salvage value. During
the same period, the company expects to generate annual revenue of $30 million by
offering television and video to mobile–phone users. Calculate the net present worth of
this investment, and determine the acceptability of the investment if the company‘s
minimum attractive rate of return is 13% per year.
Answer:
The present worth is –$227,887,000.00, which is less than zero; therefore, the
investment should be rejected.
Explanation:
PW = – 250,000,000 –25,000,000 (P/A, 13%, 7) +30,000,000 (P/A, 13%, 7)
= – 250,000,000 – (25,000,000 –30,000,000)(P/A, 13%, 7)
= – 250,000,000 + 22,113,000.00
= – 227,887,000.00
The present worth is less than zero; therefore, the investment should be rejected.
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13)
Smoothy Smoothies, a Florida–based chain that sells shakes, juices, salads, wraps, and
soups, plans to develop franchises in central Tennessee. Each new store will require an
initial investment of $270,000 and a monthly operating cost of $25,000. Each will have a
$78,500 salvage value after 5 years. The company also estimates that a new store will bring
in revenue of $40,000 each month. Determine the acceptability of the investment if the
company‘s minimum attractive rate of return is 8% per year, compounded monthly, using
the annual worth analysis.
Answer:
AW(0.67%) =$10,586.60
Since AW(0.67%) 0, the investment should be accepted.
Explanation:
Effective interest rate =0.08/12 =0.0067 or 0.67% per month
AW = – 270,000 (A/P, 0.67%, 60) –25,000 +40,000 +78,500 (A/F, 0.67%, 60)
= – 270,000 (0.0203) –25,000 +40,000 +78,500 (0.0136)
=10,586.60
Since AW (0.67%)
0, the investment should be accepted.
14)
Determine the rate of return of the following cash flow using the ERR method and the
reinvestment rate of 4% per year.
Year Expense, $ Revenue, $ Year Expense, $ Revenue, $
0140,000 –632,000 82,000
132,000 47,000 732,000 89,000
232,000 54,000 832,000 96,000
332,000 61,000 932,000 103,000
432,000 68,000 10 32,000 110,000
532,000 75,000 11 32,000 117,000
Answer:
i=14.77%
Explanation:
140,000 (F/P, i, 11) = [15,000 (P/A, 4%, 11) +7000 (P/G, 4%, 11)] (F/P, 4%, 11)
140,000 (F/P, i, 11) = [15,000 (8.7605) +7000 (40.3772)] (1.5395)
140,000 (1 +i )11 =637,426.74
(1 +i )11 =4.5530
1 +i=1.1477
i=0.1477
i=14.77%
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15)
Orangemen Lofts plans to add 300 luxury apartments to its complex in Cohoes. The cost of
the land now is $16 million including taxes and fees. The construction cost is expected to
be $64 million including the cost of the central amenities. The annual maintenance and
operating cost is expected to be $450,000. The company also estimates the market value of
the property to be 72% of the construction price after 11 years. The average occupancy rate
of 88% is expected each year. What is a minimum monthly rent required to make this
investment economically acceptable if the company’s minimum attractive rate of return is
6% per year, compounded monthly?
Answer:
$2343.4 per month
Explanation:
Effective interest rate =(1 +r/M)M– 1 =(1+0.06/12)12 –1
=0.0617 or 6.17% per year
Initial investment = – (16,000,000) – (64,000,000) = – 80,000,000
Market value at the end of year 11 = (64,000,000)(0.72) =46,080,000
To make this investment economically acceptable, the annual worth of monthly
rent (A) must be as great as the annual worth of costs each year.
AW = (–80,000,000)(A/P, 6.17%, 11) +46,080,000 (A/F, 6.17%, 11) –450,000
= (–80,000,000 * 0.1279) + (46,080,000 * 0.0662 –450,000)
= – 7,631,504.00 per year
Effective interest rate =0.06/12 =0.50 or 50.00% per month
End of year monthly rent equivalent = A(300)(0.88)(F/A, 0.50%,12)
= A(3256.5984) per year
A = – AW/ (3256.5984)
=$2343.4 per month
16)
Lane College in Jackson, Tennessee, is considering the conversion of an abandoned church
pew manufacturing plant adjacent to the school’s campus into a 34,000–square–foot
building to house the campus bookstore, a conference center, a small business incubator,
and a community computer lab. The project requires $30 million for renovation costs,
additional annual fixed operating and maintenance expenses of $100,000, and variable
expenses of 190 per square–foot over a 10–year period. The college expects to generate an
annual revenue of $7,810,000 over a 10–year period. The college uses a MARR of 7 percent
per year in its economic evaluations of the new project. The market value of the building
will be $2 million at the end of 10 years. Write the correct equation to determine if this
building should be renovated using the IRR method.
Answer:
PW = 0 = – 30,000,000 +1,250,000.00 (P/A, i*%, 10) +2,000,000 (P/F, i*%, 10)
Explanation:
PW = 0 = – 30,000,000 + [–100,000 – (190) (34,000) +7,810,000] (P/A, i*%, 10) +
2,000,000 (P/F, i*%, 10)
= – 30,000,000 +1,250,000.00 (P/A, i*%, 10) +2,000,000 (P/F, i*%, 10)
If i*% 7%, the building should be renovated.
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