978-0133546408 chapter 10 Solution Manual Part 2

P10-9. NPV and maximum return

LG 3; Challenge

a. N  4, I  10%, PMT  $44,400

Solve for PV  $140,742.03

At a cost of capital of 10%, the NPV is −$9,258, which means that the project is not acceptable.

P10-10. NPV—mutually exclusive projects

LG 3; Intermediate

a. and b.

Press A

CF0  −$85,000; CF1  $18,000; F1  8

Press B

CF0  −$60,000; CF1  $12,000; CF2  $14,000; CF3  $16,000; CF4  $18,000;

Press C

CF0  −$130,000; CF1  $50,000; CF2  $30,000; CF3  $20,000; CF4  $20,000;

c. Ranking—using NPV as criterion

Rank Press NPV

d. Profitability Indexes

2 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition

Press C: $145,043.89  $130,000  1.12

P10-11. Personal finance: Long-term investment decisions, NPV method

LG 3

Key information:

Cost of MBA program $100,000

($50,000 for tuition and $50,000 for lost earnings)

P10-12. Payback and NPV

LG 2, 3; Intermediate

a.

Project Payback Period

b. Worksheet keystrokes

Year Project A Project B Project C

0$40,000 $40,000 $40,000

Solve for

NPV

$2,565.82 $322.53 $5,454.17

Accept Reject Accept

Project C is preferred using the NPV as a decision criterion.

Chapter 3: Financial Statements and Ratio Analysis 3

c. At a cost of 16%, Project C has the highest NPV. Because of Project C’s cash flow characteristics, high early-year

cash inflows, it has the lowest payback period and the highest NPV.

P10-13. NPV and EVA

LG 3; Intermediate

P10-14. IRR—Mutually exclusive projects

LG 4; Intermediate

IRR is found by solving:

1

$0 initial investment

(1 IRR)

nt

t

CF

=

é ù

= –

ê ú

+

ë û

å

Project A

CF0  $90,000; CF1  $20,000; CF2  $25,000; CF3  $30,000; CF4  $35,000; CF5  $40,000

Project B

CF0  $490,000; CF1  $150,000; CF2  $150,000; CF3  $150,000; CF4  $150,000

Project C

CF0  $20,000; CF1  $7500; CF2  $7500; CF3  $7500; CF4  $7500; CF5  $7500

Project D

CF0  $240,000; CF1  $120,000; CF2  $100,000; CF3  $80,000; CF4  $60,000

P10-15. IRR

LG 4; Intermediate

The IRR of the project is 4%. Because the IRR is lower than the firm’s cost of capital, the firm should reject the

4 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition

each of the next two years. In a project like this, the IRR decision rule is the opposite of the normal case. Because

P10-16. IRR—Mutually exclusive projects

LG 4; Intermediate

a. and b.

Project X

1 2345

$100,000 $120,000 $150,000 $190,000 $250,000

$0 $500,000

(1 IRR) (1 IRR) (1 IRR) (1 IRR) (1 IRR)

= + + + + –

+ + + + +

CF0  −$500,000; CF1  $100,000; CF2  $120,000; CF3  $150,000; CF4  $190,000

CF5  $250,000

Solve for IRR  15.67; since IRR  cost of capital, accept the project.

Project Y

1 2345

$140,000 $120,000 $95,000 $70,000 $50,000

$0 $325,000

(1 IRR) (1 IRR) (1 IRR) (1 IRR) (1 IRR)

= + + + + –

+ + + + +

CF0  $325,000; CF1  $140,000; CF2  $120,000; CF3  $95,000; CF4  $70,000

CF5  $50,000

Solve for IRR  17.29%; because IRR  cost of capital, accept the project.

c. Project Y, with the higher IRR, is preferred, although both are acceptable.

P10-17. Personal Finance: Long-term investment decisions, IRR method

LG 4; Intermediate

IRR is the rate of return at which NPV equals zero

P10-18. IRR, investment life, and cash inflows

LG 4; Challenge

a. N  10, PV  −$61,450, PMT  $10,000

b. I  15%, PV  $61,450, PMT  $10,000

c. N  10, I  15%, PV  $61,450

Chapter 3: Financial Statements and Ratio Analysis 5

Solve for PMT  $12,244.04

P10-19. NPV and IRR

LG 3, 4; Intermediate

a. N  7, I  10%, PMT  $4,000

b. N  7, PV  $18,250, PMT  $4,000

c. The project should be accepted because the NPV  0 and the IRR  the cost of capital.

P10-20. NPV, with rankings

LG 3, 4; Intermediate

a. NPVA  $45,665.50 (N  3, I  15, PMT  $20,000)  $50,000

NPVB Key strokes

NPVC Key strokes

NPVD Key strokes

b.

Rank Press NPV

1 C $7,088.02

c. Using the calculator, the IRRs of the projects are:

6 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition

Project IRR

A 9.70%

Note: Because Project A was the only rejected project from the four projects, all that was

needed to find the minimum acceptable cost of capital was to find the IRR of A.

P10-21. All techniques, conflicting rankings

LG 2, 3, 4: Intermediate

a.

Project A Project B

Year

Cash

Inflows

Investment

Balance Year

Cash

Inflows

Investment

Balance

0$150,000 0 $150,000

1 $45,000 105,000 1 $75,000 75,000

Chapter 3: Financial Statements and Ratio Analysis 7

IRRB:

CF0  $150,000; CF1  $75,000; CF2  $60,000; CF3  $120,000

Solve for IRR  22.71%

e.

Rank

Project Payback NPV IRR

A 2 1 2

B 1 2 1

The project that should be selected is A. The conflict between NPV and IRR is due partially to the reinvestment

f. NPVA:

CF0  $150,000; CF1  $45,000; F1  6

NPVB:

At a cost of capital of 12%, the NPV of Project A is $35,013, and the NPV of Project B is $37,436. In this case,

P10-22. Payback, NPV, and IRR

LG 2, 3, 4; Intermediate

a. Payback period

b. NPV computation

c.

1 2 3 4 5

$20,000 $25,000 $30,000 $35,000 $40,000

$0 $95,000

(1 IRR) (1 IRR) (1 IRR) (1 IRR) (1 IRR)

= + + + + –

+ + + + +

d. NPV $9,080; because NPV  0; accept

8 Gitman/Zutter Principles of Managerial Finance, Brief, Seventh Edition

P10-23. NPV, IRR, and NPV profiles

LG 3, 4, 5; Challenge

a. and b.

Project A

CF0  $130,000; CF1  $25,000; CF2  $35,000; CF3  $45,000

Project B

CF0  $85,000; CF1  $40,000; CF2  $35,000; CF3  $30,000

c.

Data for NPV Profiles

NPV

Discount Rate A B

0% $80,000 $35,000

12% $15,238 $9,161

d. The net present value profile indicates that there are conflicting rankings at a discount rate less than the

intersection point of the two profiles (approximately 15%). The conflict in rankings is caused by the relative cash

Chapter 3: Financial Statements and Ratio Analysis 9

e. Project A has an increasing cash flow from Year 1 through Year 5, whereas Project B has a decreasing cash flow