CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
71. Mulroney Corp. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0.
Project X has an expected life of 2 years with after-tax cash inflows of $6,000 and $7,800 at the end of Years 1 and 2,
respectively. In addition, Project X can be repeated at the end of Year 2 with no changes in its cash flows. Project Y has
an expected life of 4 years with after-tax cash inflows of $4,300 at the end of each of the next 4 years. Each project has a
WACC of 8%. Using the replacement chain approach, what is the NPV of the most profitable project?
a.
$4,242
b.
$4,246
c.
$4,286
d.
$4,325
e.
$4,433
Profit
$10,900
MODERATE
12-2 Analysis of an Expansion Project
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
72. Wilson Co. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0.
Project X has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,500 at the end of Years 1 and 2,
respectively. In addition, Project X can be repeated at the end of Year 2 with no changes in its cash flows. Project Y has
an expected life of 4 years with after-tax cash inflows of $4,600 at the end of each of the next 4 years. Each project has a
WACC of 11%. What is the equivalent annual annuity of the most profitable project?
a.
$1,345.50
b.
$1,346.30
c.
$1,361.52
d.
$1,376.74
e.
$1,411.15
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
73. Carlyle Inc. is considering two mutually exclusive projects. Both require an initial investment of $15,000 at t = 0.
Project S has an expected life of 2 years with after-tax cash inflows of $7,000 and $12,000 at the end of Years 1 and 2,
respectively. In addition, Project S can be repeated at the end of Year 2 with no changes in its cash flows. Project L has
an expected life of 4 years. Each project has a WACC of 9%. What is the equivalent annual annuity of the most
profitable project?
a.
$569.67
b.
$792.34
c.
$865.31
d.
$1,522.18
e.
$1,846.54
c
MODERATE
12-7 Unequal Project Lives
74. TexMex Food Company is considering a new salsa whose data are shown below. The equipment to be used would be
depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no change in net
operating working capital would be required. Revenues and other operating costs are expected to be constant over the
project’s 3-year life. However, this project would compete with other TexMex products and would reduce their pre-tax
annual cash flows. What is the project’s NPV? (Hint: Cash flows are constant in Years 1–3.)
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
WACC
10.0%
Pre-tax cash flow reduction for other products (cannibalization)
−$5,000
Investment cost (depreciable basis)
$80,000
Straight-line depreciation rate
33.333%
Annual sales revenues
$67,500
Annual operating costs (excl. depreciation)
−$25,000
Tax rate
35.0%
a.
$3,636
b.
$3,828
c.
$4,019
d.
$4,220
e.
$4,431
MODERATE/CHALLENGING
12-2 Analysis of an Expansion Project
Project NPV
Bloom’s: Analysis
Multiple Choice: Problem
75. Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns
the building that would be used, and it could sell it for $100,000 after taxes if it decides not to open the new office. The
equipment for the project would be depreciated by the straight-line method over the project’s 3-year life, after which it
would be worth nothing and thus it would have a zero salvage value. No change in net operating working capital would be
required, and revenues and other operating costs would be constant over the project’s 3-year life. What is the project’s
NPV? (Hint: Cash flows are constant in Years 1–3.)
WACC
10.0%
Opportunity cost
$100,000
Net equipment cost (depreciable basis)
$65,000
Straight-line depreciation rate for equipment
33.333%
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
Annual sales revenues
$123,000
Annual operating costs (excl. depreciation)
$25,000
Tax rate
35%
a.
$10,521
b.
$11,075
c.
$11,658
d.
$12,271
e.
$12,885
MODERATE/CHALLENGING
12-2 Analysis of an Expansion Project
FOFM.BRIG.16.12.02 – Analysis of an Expansion Project
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
Project NPV
Bloom’s: Analysis
Multiple Choice: Problem
76. Atlas Corp. is considering two mutually exclusive projects. Both require an initial investment of $10,000 at t = 0.
Project S has an expected life of 2 years with after-tax cash inflows of $6,000 and $8,000 at the end of Years 1 and 2,
respectively. Project L has an expected life of 4 years with after-tax cash inflows of $4,373 at the end of each of the next
4 years. Each project has a WACC of 9.25%, and Project S can be repeated with no changes in its cash flows. The
controller prefers Project S, but the CFO prefers Project L. How much value will the firm gain or lose if Project L is
selected over Project S, i.e., what is the value of NPVL – NPVS?
a.
$56.50
b.
$62.15
c.
$68.37
d.
$75.21
e.
$82.73
a
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
77. Desai Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be
constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise
with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no
salvage value. No change in net operating working capital would be required. This is just one of many projects for the
firm, so any losses on this project can be used to offset gains on other firm projects. What is the project’s expected NPV?
WACC
10.0%
Net investment cost (depreciable basis)
$200,000
Units sold
50,000
Average price per unit, Year 1
$25.00
Fixed oper. costs excl. depreciation (constant)
$150,000
Variable oper. cost/unit, Year 1
$20.20
Annual depreciation rate
33.333%
Expected inflation rate per year
5.00%
Tax rate
40.0%
a.
$15,925
b.
$16,764
c.
$17,646
d.
$18,528
e.
$19,455
c
MODERATE/CHALLENGING
12-7 Unequal Project Lives
FOFM.BRIG.16.12.07 – Unequal Project Lives
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
Replacement chain approach
Multiple Choice: Problem
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
78. Poulsen Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be
constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise
with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no
salvage value. No change in net operating working capital would be required. This is just one of many projects for the
firm, so any losses on this project can be used to offset gains on other firm projects. The marketing manager does not
think it is necessary to adjust for inflation since both the sales price and the variable costs will rise at the same rate, but the
CFO thinks an inflation adjustment is required. What is the difference in the expected NPV if the inflation adjustment is
made versus if it is not made?
WACC
10.0%
Net investment cost (depreciable basis)
$200,000
Units sold
50,000
Average price per unit, Year 1
$25.00
Fixed oper. costs excl. depreciation (constant)
$150,000
Variable oper. cost/unit, Year 1
$20.20
Annual depreciation rate
33.333%
Expected inflation
4.00%
Tax rate
40.0%
a.
$12,018
b.
$12,650
c.
$13,316
d.
$13,982
e.
$14,681
CHALLENGING
12-2 Analysis of an Expansion Project
NPV including inflation
Bloom’s: Analysis
Multiple Choice: Problem
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
79. Foley Systems is considering a new investment whose data are shown below. The equipment would be depreciated on
a straight-line basis over the project’s 3-year life, would have a zero salvage value, and would require additional net
operating working capital that would be recovered at the end of the project’s life. Revenues and other operating costs are
expected to be constant over the project’s life. What is the project’s NPV? (Hint: Cash flows from operations are constant
in Years 1 to 3.)
WACC
10.0%
Net investment in fixed assets (basis)
$75,000
Required net operating working capital
$15,000
Straight-line depreciation rate
33.333%
Annual sales revenues
$75,000
Annual operating costs (excl. depreciation)
$25,000
Tax rate
35.0%
a.
$23,852
b.
$25,045
c.
$26,297
d.
$27,612
e.
$28,993
a
CHALLENGING
12-2 Analysis of an Expansion Project
FOFM.BRIG.16.12.02 – Analysis of an Expansion Project
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
Project NPV
Bloom’s: Analysis
Multiple Choice: Problem
80. Thomson Media is considering some new equipment whose data are shown below. The equipment has a 3-year tax life
and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value
at the end of Year 3, when the project would be closed down. Also, additional net operating working capital would be
Multiple Choice: Problem
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
required, but it would be recovered at the end of the project’s life. Revenues and other operating costs are expected to be
constant over the project’s 3-year life. What is the project’s NPV?
WACC
10.0%
Net investment in fixed assets (depreciable basis)
$70,000
Required net operating working capital
$10,000
Straight-line depreciation rate
33.333%
Annual sales revenues
$75,000
Annual operating costs (excl. depreciation)
$30,000
Expected pre-tax salvage value
$5,000
Tax rate
35.0%
a.
$20,762
b.
$21,854
c.
$23,005
d.
$24,155
e.
$25,363
c
1
CHALLENGING
12-2 Analysis of an Expansion Project
Project NPV
Bloom’s: Analysis
Multiple Choice: Problem
81. Florida Car Wash is considering a new project whose data are shown below. The equipment to be used has a 3-year
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS
tax life, would be depreciated on a straight-line basis over the project’s 3-year life, and would have a zero salvage value
after Year 3. No change in net operating working capital would be required. Revenues and other operating costs will be
constant over the project’s life, and this is just one of the firm’s many projects, so any losses on it can be used to offset
profits in other units. If the number of cars washed declined by 40% from the expected level, by how much would the
project’s NPV change? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.)
WACC
10.0%
Net investment cost (depreciable basis)
$60,000
Number of cars washed
2,800
Average price per car
$25.00
Fixed oper. costs (excl. depreciation)
$10,000
Variable oper. cost/unit (i.e., VC per car washed)
$5.375
Annual depreciation
$20,000
Tax rate
35.0%
a.
−$28,939
b.
−$30,462
c.
−$32,066
d.
−$33,753
e.
−$35,530
e
CHAPTER 12—CASH FLOW ESTIMATION AND RISK ANALYSIS