Reference no: EM132375142
Problem Set: Long-Term Investment Decisions
Complete the following problems from Chapters 10-12 in Principles of Managerial Finance:
Question 1: Payback comparisons Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new machine and must choose between two alternative ones. The first machine requires an initial investment of $14,000 and generates annual after-tax cash inflows of $3,000 for each of the next 7 years. The second machine requires an initial investment of $21,000 and provides an annual cash inflow after taxes of $4,000 for 20 years.
a. Determine the payback period for each machine.
b. Comment on the acceptability of the machines, assuming they are independent projects.
c. Which machine should the firm accept? Why?
d. Do the machines in this problem illustrate any of the weaknesses of using payback? Discuss.
Question 2: IRR: Mutually exclusive projects Bell Manufacturing is attempting to choose the better of two mutually exclusive projects for expanding the firm's warehouse capac¬ity. The relevant cash flows for the projects are shown in the following table. The firm's cost of capital is 15%.
| |
Project X |
Project Y
|
|
Initial investment
|
-$500,000
|
-$325,000
|
|
Year (t)
|
Cash inflows (CFt)
|
|
1
|
$100,000
|
$140,000
|
|
2
|
120,000
|
120,000
|
|
3
|
150,000
|
95,000
|
|
4
|
190,000
|
70,000
|
|
5
|
250,000
|
50,000
|
a. Calculate the IRR to the nearest whole percent for each of the projects.
b. Assess the acceptability of each project on the basis of the IRRs found in part a.
c. Which project, on this basis, is preferred?
Question 3: Replacement versus expansion cash flows Tesla Systems has estimated the cash flows over the 5-year lives for two projects, A and B. These cash flows are summarized in the table below.
| |
Project A |
Project B
|
|
Initial investment
|
-$4,650,000
|
$1,550,000
|
|
Year
|
Operating cash inflows
|
|
1
|
$ 560,000
|
$380,000
|
|
2
|
925,000
|
380,000
|
|
3
|
1,350,000
|
380,000
|
|
4
|
2,225,000
|
380,000
|
|
5
|
3,400,000
|
380,000
|
a. If project A, which requires an initial investment of $4,650,000, is a replacement for project B and the $1,550,000 initial investment shown for project B is the after-tax cash inflow expected from liquidating project B, what would be the net cash flows for this replacement decision?
b. Instead, if project A is an expansion decision, what would be the net cash flows and how can it be viewed as a special form of a replacement decision? Explain.