Eco500 Week 10

Chapter 17

1. Projective evaluation:

a. NINV = $20,000 and NCF = (5000  4000)(1  .4) + 4000 = $4600/year

$20,000 = $4,600∙(Interest factor for 5 years). 20,000/4,600 = 4.3478.

Interest factor = 4.3478, which helps to find the internal rate of return (IRR) of this project. This interest factor represents the present value of a $1 annuity for 5 years discounted at r%. Looking up 4.3478 in Table 5, this value falls between 4.4518 and 4.3295, which corresponds to discount rates of 4% and 5% respectively for an internal rate of return. Interpolating between these values yields an internal rate of return of approximately 4.85%, which is far lower than the firm’s cost of capital of 12%. Students can use a calculator or Excel to find the IRR, which is 4.847%.

For the NPV, students can use tables to find the Annuity Interest Factor at 12A% to be 3.6048) to find: NPV = $4,600(3.6048)  $20,000 = $3,418. Alternatively, financial calculators or Excel can find the NPV to be -3,418.03.

b. Since the NPV of the project is negative, the firm should reject the project. Likewise, by the IRR criterion, the project should be rejected, because the internal rate of return of 4.85% is less than the cost of capital of 12%.

5. The Charlotte Bobcats is considering purchasing a superstar’s contract.

Depreciation/year = $800,000/4 = $200,000.

This involves a series of payments of unequal value.

NCF1 = (450,000  200,000)(1 .4) + 200,000 = $350,000

NCF2 = (350,000  200,000)(1 .4) + 200,000 = $290,000

NCF3 = (275,000  200,000)(1 .4) + 200,000 = $245,000

NCF4 = (200,000  200,000)(1 .4) + 200,000 = $200,000

a. The IRR calculation: $800,000 = $350,000/(1+r)1 + $290,000/(1+r)2 + $245,000/(1+r)3 + $200,000/(1+r)4. We can find the “r” that makes the left-hand and right-hand side equal by trial and error using PVIF...