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## Chapter IX Tutorial

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**ChapterIXTutorial**Capital Budgeting Techniques**Capital BudgetingTechniques**Calculate, interpret, and evaluate the payback period. Calculate, interpret, and evaluate the present value (NPV). Calculate, interpret, and evaluate the internal rate of return (IRR).**Exercise 9 - 3**Project Kelvin will cost $45,000 and generate cash inflows of $20,000 per year for the next 3 years Project Thompson will cost $275,000 and generate cash inflows of $60,000 per year for 6 years. Using an 8% cost of capital, calculate each project’s NPV and make a recommendation based on your findings**Exercise 9 - 4**Calculate the IRR for each of the following projects and recommend best project. Project T-shirt requires initial investment of $15,000 and generates cash inflows of $8,000 per year for 4 years. Project Board Shorts requires an initial investment of $25,000 and produces cash inflows of $12,000 per year for 5 years.**Exercise 9 - 4 Solution**Project T-Shirt PV = -15,000 N = 4 PMT = 8,000 Solve for I IRR = 39.08%**Problem 9 - 1**Payback period Jordan Enterprises is considering a capital expenditure that requires an initial investment of $42,000 and returns after-tax inflows of $7,000 per year for 10 years. The firm has maximum acceptable payback period of 8 years. Determine the payback period for this project. Should the company accept the project? Why?**Problem 9 - 1 Solution**(a) $42,000/$7,000 = 6 years (b) The company should accept the project, since 6 < 8.**Problem 9 - 3**• Choosing between 2 projects with acceptable payback periods • Each project requires $100,000 investment • Maximum payback period 4 years • Determine payback period of each project. • Which one should they choose? • Explain why is one of the projects a better choice.**Problem 9 - 4**NPV Calculate the NPV for the following 20-year projects. Comment on the acceptability of each Opportunity cost is 14% Initial investment is $10,000; cash inflows are $2,000 per year. Initial investment is $10,000; cash inflows are $2,000 per year. Initial investment is $10,000; cash inflows are $2,000 per year.**Problem 9 - 7**NPV Car inventor has offered Simes choice of either one time payment $1,500,000 today or a series of 5 year-end payments of $385,000 If Simes has cost of capital 9%, which form of payment would they choose? What yearly payment would make the two offers identical in value at a cost of capital of 9% Would your answer be different if the yearly payments were made at the beginning of each year? Show the difference. The after-tax cash inflows are projected to $250,000 per year for 15 years. Will this factor change the decision?**Problem 9 - 9**• NPV- exclusive projects • Hook industries is considering the replacement of a drill press • Cost of capital is 15% • Calculate NPV of each press. • Evaluate acceptability. • Rank the presses best to worst**Problem 9 - 13**IRR, investment life and cash inflows Oak enterprises accepts projects earning more than 15%. Oak is considering a 10 year project that provides $10,000 annual cash inflows and requires $61,450 initial investment. Determine IRR. Is it acceptable? Assuming cash inflows stay same how many additional years would the flows have to continue to make IRR 15%? With given life, initial investment, and cost of capital what is the minimum annual cash inflow the firm should accept?**Problem 9 - 21**MACRS • Integrative -Complete investment decision • Existing • 10yrs ago at $1,000,000 • Sells $1,200,000 • New • Cost $2,200,000 • 5yrs, MACRS • Sales $1,600,000 increase per year • Costs 50% of Sales • Cost of Capital 11% • Tax 40% Calculate initial investment. Determine incremental operating cash flows. Determine the terminal cash flow. Depict on a time line the relevant cash flows.