Question Questions 6 E12-1 Birkenstock is considering an investment in a nylon-knitting machine. The machine requires an initial investment of $25000 has a 5-year life and has no residual value at the end of the 5 years. The company’s cost of capital is 12%. Known with less certainty are the actual after-tax cash inflows for each of the 5 years. The company has estimated expected cash inflows for three scenarios: pessimistic most likely and optimistic. These expected cash inflows are listed in the following table. Calculate the range for the NPV given each scenario. Expected cash inflows Year Pessimistic Most likely Optimistic 1 $5500 $ 8000 $10500 2 6000 9000 12000 3 7500 10500 14500 4 6500 9500 11500 5 4500 6500 7500 E12-2 You wish to evaluate a project requiring an initial investment of $45000 and having a useful life of 5 years. What minimum amount of annual cash inflow do you need if your firm has an 8% cost of capital? If the project is forecast to earn $12500 per year over the 5 years what is its IRR? Is the project acceptable? E12-3 Like most firms in its industry Yeastime Bakeries uses a subjective risk assessment tool of its own design. The tool is a simple index by which projects are ranked by level of perceived risk on a scale of 0-10. The scale is recreated in the following table. Risk index Required return 0 4.0% (current risk-free rate) 1 4.5 2 5.0 3 5.5 4 6.0 5 6.5 (current IRR) 6 7.0 7 7.5 8 8.0 9 8.5 10 9.0 The firm is analyzing two projects based on their RADRs. Project Sourdough requires an initial investment of $12500 and is assigned a risk index of 6. Project Greek Salad requires an initial investment of $7500 and is assigned a risk index of 8. The two projects have 7-year lives. Sourdough is projected to generate cash inflows of $5500 per year. Greek Salad is projected to generate cash inflows of $4000 per year. Use each project’s RADR to select the better project. E12-4 Outcast Inc. has hired you to advise the firm on a capital budgeting issue involving two unequal-lived mutually exclusive projects M and N. The cash flows for each project are presented in the following table. Calculate the NPV and the annualized net present value (ANPV) for each project using the firm’s cost of capital of 8%. Which project would you recommend? Project M Project N Initial investment $35000 $55000 Year Cash inflows 1 $12000 $18000 2 25000 15000 3 30000 25000 4 ? 10000 5 ? 8000 6 ? 5000 7 ? 5000 E12-5 Longchamps Electric is faced with a capital budget of $150000 for the coming year. It is considering six investment projects and has a cost of capital of 7%. The six projects are listed in the following table along with their initial investments and their IRRs. Using the data given prepare an investment opportunities schedule (IOS). Which projects does the IOS suggest should be funded? Does this group of projects maximize NPV? Explain. Project Initial investment IRR 1 $75000 8% 2 40000 10 3 35000 7 4 50000 11 5 45000 9 6 20000 6
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