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Chapter 8
Answers to Review Problems
Finance For Executives – 4th Edition
1. Pondering an investment offer.
The offer is not “ridiculous.” The problem is that the cash flows in the deal have been incorrectly
specified. The $15,000 investment promises a $17,000 payoff in one year. The “less than 4 percent” return
calculation is presumably based on a payoff of $17,000 less 12 percent interest on $12,000 or a net of
2. The effect of inflation on the investment decision.
The financial manager is correct. Why? The accountant is arguing that the projected cash flows (the
numerator in the equation) are nominal amounts. That is, they assume some rate of inflation. It is
impossible to predict inflation rates very far into the future, so taking the most recent government figures
3. Changing machines in a world without taxes.
For all questions from a. to d., the first issue is the estimation of the project’s economic or useful life. The
existing machine can last another 10 or more years. However, the new one, which will perform exactly
the same operations, has an economic life of only 5 years, which means that it will be obsolete within 5
a.
By changing machines, the cash position of Clampton will immediately decrease by $110,000, the
difference between the purchase price of the new machine ($110,000) and the resale price ($0) of the
Using a spreadsheet
A B C D E F G
8-1
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
2
4
5Cost of capital 10%
6
7Net present value $3,724
8
9The formula in cell B7 is: =B3 + NPV(B5,C3:G3).
10
According to the net present value rule, the machine should be changed. Note that the depreciation
b.
The impact of changing machines on the relevant cash flows of the Clampton Company will be exactly
c.
Using a spreadsheet
A B C D E F G
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
2
4
5Cost of capital 10%
6
7Net present value $1,631
8
9The formula in cell B7 is: =B3 + NPV(B5,C3:G3).
10 12345
11
13
Accumulated discounted
15
16
Discounted payback
period – – – – 4.93
17
18
The formula in cell C12 is: =C3/(1+$B$5)^C10. Then copy formula in cell C12 to cells D12, E12, F12,
and G12.
8-2
19
The formula in cell C14 is: =C12. The formula in cell D14 is: =C14+D12. Then copy formula in cell
D14 to cells E14, F14, and G14.
21
According to the net present value rule, machine B should be purchased.
d.
If a mistake has been made, it is in the estimation of the economic life of Machine A. The decision taken
two years ago was taken with the assumption that its economic life was 5 years, when actually it was 2
Was a mistake made? Not necessarily. The useful life estimation was simply off the mark. From a
decision-making perspective, an investigation into the process of determining economic life of pieces of
4. Changing machines in a world with taxes.
a.
Using a spreadsheet
A B C D E F G
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
2
Savings before depreciation
14
15 The values in rows 3, 4, and 7 are data.
16 The formulas in cell C5 to G5 is: =SLN(-$B$3,0,5), where 5 the depreciation period.
8-3
17 The formula in cell C6 is: =C4-C5. Then copy formula in cell C6 to cells D6, E6, F6, and G6.
18 The formula in cell C8 is: =C6*(1-C7). Then copy formula in cell C8 to cells D8, E8, F8, and G8.
19 The formula in cell B9 is: =B3+B8+B5. Then copy formula in cell B9 to cells C9, D9, E9, F9, G9.
20 The formula in cell B13 is: =B9 + NPV(B11,C9:G9).
21
According to the net present value rule, the machine should not be changed, contrary to the case when the
company is not taxed, because the net present value is negative (minus $2,995). Taxes have three effects
on the estimation of the net present value:
b.
Using a spreadsheet
A B C D E F G
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
2
3 Purchase of new machine -$110,000
18
19 The values in rows 3, 4, 6, 9, 11, and 15 are data.
20 The formulas in cell C5 to G5 is: =SLN($B$3,0,5), where 5 the depreciation period.
21 The formula in cell C7 is: =C5+C6. Then copy formula in cell C7 to cells D7, E7, F7, and G7.
22 The formula in cell C8 is: =C4-C7. Then copy formula in cell C8 to cells D8, E8, F8, and G8.
8-4
23 The formula in cell C10 is: =C8*(1-C9). Then copy formula in cell C10 to cells D10, E10, F10, and G10.
24 The formula in cell C12 is: =C11*C9.
25 The formula in cell B13 is: =B3+B10+B7+B12. Then copy formula in cell B13 to cells C13, D13, E13, F13, G13.
26 The formula in cell B17 is: =B13 + NPV(B15,C13:G13).
27
According to the net present value rule, the machine should be changed because the net present value is
positive, although nearly insignificantly positive ($228).
Note that the difference in the net present value between the question in part a. and the question in part b.
5. Investing in the production of toys.
a.
The cash flows (CFt) generated by the project can be estimated from equation (8.2):
where EBITt, Taxt, Dept, WCR, and Capext are the contribution of the project to the firm’s earnings
Using a calculator
$ thousands Now Year 1 to 4 Year 5
b.
8-5
The net present value (NPV) in thousand dollars of the project is:
5432 )12.1(
687,5$
)12.1(
772,4$
)12.1(
772,4$
)12.1(
772,4$
)12.1(
772,4$
345,16$NPV
= $ 1,286,188
A B C D E F G
1in thousands Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
2
2
4
2
5The values in rows 3, 4, 5, 7, 10, 12, 13, 16, 17, and 21 are data.
26 The formula in cell C6 is: =C4*C5. Then copy formula in cell C6 to cells D6, E6, F6, and G6.
27 The formula in cell C8 is: =SLN($B$16,0,5), where 5 is the product’s economic life.
The formula in cell C11 is: =C9*(1-C10). Then copy formula in cell C11 to cells D11, E11, F11, and G11.
28 The formula in cell B14 is: =B12+B13. Then copy formula in cell B14 to cells C14, D14, E14, F14, and G14.
2
9
The formula in cell B15 is: =B14. The formula in C15 is =C15-B15. Then copy formula in cell C15 to cells D15,
E15, F15, and G15.
3The formula in cell G18 is: =G10*G17.
8-6
0
3
1
The formula in cell B19 is: =B11+B8-B15-B16+B17-B18. Then copy formula in cell B19 to cells C19, D19, E19,
F19, and G19.
3
2The formula in cell B23 is: =B19 + NPV(B21,C19:G19).
3
3
Using a spreadsheet
8-7
