Reference no: EM132488881

Problem 1: Consider the following two projects:

Year             Cash Flow (A)          Cash Flow (B)

0                    -$364,000                 -$52,000

1                   46,000                        25,000

2                 68,000                        22,000

3                  68,000                     21,500

4                  458,000                  17,500

Whichever project you choose, if any, you require a return of 11 percent on your investment.

1) Suppose these two projects are independent. Which project(s) should you accept based on:

a. The Payback rule? Explain. (10%)

b. The Profitability Index rule? Explain. (10%)

c. The IRR rule? Explain. (10%)

d. The NPV rule? Explain. (10%)

2) Suppose these two projects are mutually exclusive. Which project should you accept? Explain. (10%)

Problem 2: The company is considering a new four-year expansion project that requires an initial investment in manufacturing machinery of $1,670,000. The machinery will be depreciated straight-line to zero over its four-year tax life (depreciation rate is 25% per year). At the end of the project, the machinery can be sold for 26% of its original cost. The project requires an initial investment in net working capital of $198,000; all of which will be recovered at the end of the project. The project is estimated to generate $1,850,000 in annual sales; with annual costs of $1,038,000. The tax rate is 21 percent and the required return for the project is 16.4%.

Instructions:

1. Calculate initial outlay (total cash flow in Year 0). (5%)

2. Calculate after-tax salvage value. (5%)

3. Complete the pro forma and determine total cash flows for each year of project's life. (25%)

4. Calculate the NPV of the project. (5%)

5. Calculate the IRR of the project. (5%)

6. Explain your decision whether you recommend to accept or reject the project. (5%)