Problem I - Use the following information for Problems 1-5.
A project costing $400 is to be depreciated straight-line over the 5 year life of the project to zero salvage value. Net income resulting from the project amounts to $100 years one and two and $150 in years 3 through 5. The project cash flows should be discounted at 14%. Ignore taxes and assume that the income stream of the project is also its cash flows.
1. What is the project's NPV?
2. What is the AAR of the project?
3. What is the payback period for the project?
4. What is this project's IRR?
5. What is this project's Profitability Index?
Problem II - Use the following cash flows for projects A and B:
Years Project A Project B
0 -$2000 -$2000
1 $500 $950
2 $600 $850
3 $700 $400
4 $800 $300
6. Calculate the payback period for projects A and B.
7. If only one can be chosen and the required rate of return is 12%, which should be accepted? Why? (Use NPV as your capital budgeting method)
8. Calculate the approximate IRR for projects A and B.
9. Calculate the Profitability Index for both projects.
Problem III - Calculate the payback period, net present value, and internal rate of return for Sunbeam Co. for the following investment in a new line of business (SunBeam SunBlock).
Year Cash Flows
0 -2,000,000
1 150,000
2 1,200,000
3 200,000
4 250,000
5 -0-
6 625,000
7 175,000
Additional information:
SunBeam generally requires a 6 year payback for a project to be undertaken, and SunBeam requires at least a return of 12% for an investment to be undertaken.
After doing the calculations be sure to answer --Should SunBeam undertake this project? Why or why not?