Birkenstock is considering an investment in a nylon-knitting machine_Answer
Birkenstock is considering an investment in a nylon-knitting machine_Answer
Birkenstock is considering an investment in a nylon-knitting machine_Answer
Birkenstock is considering an investment in a nylon-knitting machine_Answer
Birkenstock is considering an investment in a nylon-knitting machine. The machine requires an initial investment of $25,000, 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 $5,000 8,000 10,500
2 6,000 9,000 12,000
3 7,500 10,500 14,500
4 6,500 9,500 11,500
5 4,500 6,500 7,500You wish to evaluate a project requiring an initial investment of $45,000 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 $12,500 per year over the 5 years, what is its IRR? Is the project acceptable?
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 010. The scale is recreated in the following table. LG 4 E123
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 8.510 9.0
The firm is analyzing two projects based on their RADRs. Project Sourdough requires an initial investment of $12,500 and is assigned a risk index of 6. Project Greek Salad requires an initial investment of $7,500 and is assigned a risk index of 8. The two projects have 7-year lives. Sourdough is projected to generate cash inflows of $5,500 per year. Greek Salad is projected to generate cash inflows of $4,000 per year. Use each project’s RADR to select the better project.
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 $35,000 $55,000
Year Cash Inflows
1 $12,000 $18,000
2 $25,000 15,000
3 30,000 25,000
4 – 10,000
5 – 8,000
6 – 5,000
7 – 5,000Longchamps Electric is faced with a capital budget of $150,000 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 $75,000 8%
2 40,000 10
3 35,000 7
4 50,000 11
5 45,000 9
6 20,000 6Earnings before depreciation, interest, and taxes for lasting
Lasting Impressions Company’s Press
Year Old Press Press A Press B
1 $120,000 $250,000 $210,000
2 120,000 270,000 210,000
3 120,000 300,000 210,000
4 120,000 330,000 210,000
5 120,000 370,000 210,000a. For each of the two proposed replacement presses, determine: (1) Initial investment. (2) Operating cash inflows. (Note: Be sure to consider the depreciation in year 6.) (3) Terminal cash flow. (Note: This is at the end of year 5.)
b. Using the data developed in part a, find and depict on a time line the relevant cash flow stream associated with each of the two proposed replacement presses, assuming that each is terminated at the end of 5 years.
c. Using the data developed in part b, apply each of the following decision tech- niques: (1) Payback period. (Note: For year 5, use only the operating cash inflows–that is, exclude terminal cash flow–when making this calculation.) (2) Net present value (NPV). (3) Internal rate of return (IRR).
d. Draw net present value profiles for the two replacement presses on the same set of axes, and discuss conflicting rankings of the two presses, if any, resulting from use of NPV and IRR decision techniques.
e. Recommend which, if either, of the presses the firm should acquire if the firm has (1) unlimited funds or (2) capital rationing.
f. What is the impact on your recommendation of the fact that the operating cash inflows associated with press A are characterized as very risky in contrast to the low-risk operating cash inflows of press B?
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