Long-term investment decision, NPV method Jenny Jenks has researched the financial pros and cons of entering into a 1-year MBA program at her state university. The tuition and books for the master's program will have an up-front cost of $50,000. If
she enrolls in an MBA program, Jenny will quit her current job, which pays $50,000 per year after taxes (for simplicity, treat any lost earnings as part of the up-front cost). On average, a person with an MBA degree earns an extra $20,000 per year (after taxes) over a business career of 40 years. Jenny believes that her opportunity cost of capital is 6%. Given her estimates, find the net present value (NPV) of entering this MBA program. Are the benefits of further education worth the associated costs?
10.15
Internal rate of return Peace of Mind, Inc. (PMI), sells extended warranties for durable consumer goods such as washing machines and refrigerators. When PMI sells an extended warranty, it receives cash up front from the customer, but later PMI must cover any repair costs that arise. An analyst working for PMI is considering a warranty for a new line of big-screen TVs. A consumer who purchases the 2-year warranty will pay PMI $200. On average, the repair costs that PMI must cover will average $106 for each of the warranty's 2 years. If PMI has a cost of capital of 7%, should it offer this warranty for sale?
10.21
Nicholson Roofing Materials, Inc., is considering two mutually exclusive projectseach with an initial investment of $150,000. The company's boaed od directors has set a 4-year payback requirement and has set its cost of capital at 9%. The cashinflows associated with the two projects are as follows:
cash inflows (CFt)
year ProjectA ProjectB
1 $45,000 $75,000
2 45,000 60,000
3 45,000 30,000
4 45,000 30,000
5 45,000 30,000
6 45,000 30,000
a. Calculate the payback period for each project.
b. Calculate the NPV of each project at 0%
c. Calculate the NPV of each project at 9%
d. Derive the IRR of each project
e. Rank the projects by each of the techniques used. Make and justify
f. Go back one more time and calculate the NPV of each project using a cost of
capital of 12%. Does the ranking of the two projects change compared to your
answer in part e? Why?
10.24
All techniques-Decision among mutually exclusive investments Pound Industries is attempting to select the best of three mutually exclusive projects. The initial investment and after-tax cash inflows associated with these projects are shown in the following table.
Cash flows Project A Project B Project C
Initial investment (CF0) $60,000 $100,000 $110,000
Cash inflows (CFt),t = 1 to 5 $20,000 $ 31,500 $ 32,500
a. Calculate the payback period for each project.
b. Calculate the net present value (NPV) of each project, assuming that the firm has a cost of capital equal to 13%.
c. Calculate the internal rate of return (IRR) for each project.
d. Draw the net present value profiles for both projects on the same set of axes, and discuss any conflict in ranking that may exist between NPV and IRR.
e. Summarize the preferences dictated by each measure, and indicate which project you would recommend. Explain why.