Problem 1
Winston Clinic is evaluating a project that costs $52,125 and has expected net cash flows of $12,000 per year for eight years. The first inflow occurs one year after the cost outflow, and the project has a cost of capital of 12 percent.
a. What is the project's payback?
b. What is the project's NPV? Its IRR?
c. Is the project financially acceptable? Explain your answer.
Problem 2
Assume that you are the CFO at Porter Memorial Hospital. The CEO has asked you to analyze two proposed capital investments--Project X and Project Y. Each project requires a net investment outlay of $10,000, and the cost of capital for each project is 12 percent. The project's expected net cash flows are as follows:
| Year |
Project X |
Project Y |
| 0 |
-$10,000 |
-$10,000 |
| 1 |
$6,500 |
$3,000 |
| 2 |
$3,000 |
$3,000 |
| 3 |
$3,000 |
$3,000 |
| 4 |
$1,000 |
$3,000 |
a. Calculate each project's payback period, net present value (NPV), and internal rate of return (IRR).
b. Which project (or projects) is financially acceptable? Explain your answer.
Problem 3
The director of capital budgeting for Big Sky Health Systems, Inc. has estimated the following cash flows in thousands of dollars for a proposed new service:
|
Expected Net |
| Year |
Cash Flow |
| 0 |
-100 |
| 1 |
70 |
| 2 |
50 |
| 3 |
20 |
The project's cost of capital is 10 percent.
a. What is the project's payback period?
b. What is the project's NPV?
c. What is the project's IRR?
Problem 4
You have been asked by the president and CEO of Kidd Pharmaceuticals to evaluate the proposed acquisition of a new labeling machine for one of the firm's production lines. The machine's price is $50,000, and it would cost another $10,000 for transportation and installation. The machine falls into the MACRS three-year class, and hence the tax depreciation allowances are 0.33, 0.45, and 0.15 in Years 1, 2, and 3, respectively. The machine would be sold after three years because the production line is being closed at that time. The best estimate of the machine's salvage value after three years of use is $20,000. The machine would have no effect on the firm's sales or revenues, but it is expected to save Kidd $20,000 per year in before-tax operating costs. The firm's tax rate is 40 percent and its corporate cost of capital is
10 percent.
a. What is the project's net investment outlay at Year 0?
b. What are the project's operating cash flows in Years 1, 2, and 3?
c. What are the terminal cash flows at the end of Year 3?
d. If the project has average risk, is it expected to be profitable?