FIN 362 â Capital Budgeting Exercises Please use Excel to solve all problems. Calculate the following projectâs NPV, IRR, MIRR, payback, and…

FIN 362 – Capital Budgeting Exercises

Please use Excel to solve all problems.

• Calculate the following project’s NPV, IRR, MIRR, payback, and discounted payback:

The project’s initial investment is \$6,000.  The project lives for five years.  In the next five years, annual cash flow is \$2,000 per year.  The project’s cost of capital is 14%.

Note: For NPV and MIRR, please use two approaches: a) the formula approach; and b) the NPV and MIRR functions of Excel.

• You are evaluating whether to buy a new car or a used car.  The new car costs \$20,000, and requires an annual maintenance of \$100 per year.  You anticipate that the new car will last for 10 years.  The old car costs \$5,000, and requires an annual maintenance of \$1,000 a year.  You anticipate that the old car will last for 3 years.  No matter which car you get, after the physical life of the car, you will have to abandon it and obtain another car.  Assume that interest rate is 5% a year.
• Calculate the equivalent annual annuity for the new car and the old car.
• Which car should you get?
• Physical life vs. economic life: The Scampini Supplies Company recently purchased a new delivery truck.  The new truck costs \$22,500, and it is expected to generate after-tax cash flows of \$6,250 per year.  The truck has a 5-year expected life.  The expected year-end after-tax salvage values are listed below.  The project’s cost of capital is 10%.

 Year Annual After-tax Cash Flow After tax salvage value 0 -22,500 22,500 1 6,250 17,500 2 6,250 14,000 3 6,250 11,000 4 6,250 5,000 5 6,250 0

Should the firm operate the truck until the end of its 5-year physical life?  If not, what is its optimal economic life?

• Growth Option: Martin Development Co. is deciding whether to proceed with project X.  The cost would be \$9 million in Year 0.  There is a 50% chance that X would be hugely successful, and would generate annual after tax CF of \$6 mil per year during years 1, 2, and 3.  However, there is 50% chance that X would be less successful, and would generate only \$1 mil per year for years 1, 2, and 3.  If Project X is hugely successful, it would open the door to another investment project Y, that would require a \$10 mil outlay at the end of Year 2, and would generate \$20 mil inflow for the company at the end of year 3.  The cost of capital for all projects is 11%.
• If the company does not consider the value of real options, what is project X’s NPV?
• What is project X’s NPV considering the growth option?
• Option of waiting (Investment timing option): Kim Hotels is interested in developing a new hotel in Seoul.  The company estimates that the hotel would require an initial investment of \$20 million.  Kim expects that the hotel will produce positive cash flows of \$3 million a year at the end of each of the next 20 years.  The project’s cost of capital is 13%.
• What is the project’s NPV?
• While Kim expects the cash flows to be \$3 million a year, it recognizes that the cash flows could in fact be much higher or lower, depending on whether the government imposes a large hotel tax.  One year from now, it will know whether the tax will be imposed.  There is a 50% chance that the tax will be imposed, and the annual CF will be \$2.2 mil a year.  If the tax is not imposed, then the annual CF will be \$3.8 million.  Kim is trying to decide whether to develop the hotel now or to wait for one year to find out whether the tax will be imposed.  If Kim waits for a year, the initial investment will remain \$20 million.  Assume that all CF are discounted at 13%.  Using decision tree analysis, should Kim proceed with the project today or should it wait for one year?

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