Ch6 Bmpr Answers

CHAPTER 6

Making Investment Decisions with

The Net Present Value Rule

Answers to Problem Sets

1. a, b, d, g, h.

2. Real cash flow = 100,000/1.04 = $96,154; real discount rate = 1.08/1.04 - 1 = .03846

PV =

3. a. False

b. False

c. False

d. False

4. The longer the recovery period, the less the -present value of depreciation tax shields. This is true regardless of the discount rate. If r = .10, then 35% of the 5-year schedule’s PV is .271. The same calculation for the 7-year schedule yields .252.

| 2010 | 2011 | 2012 | 2013 | 2014 |

Working capital | 50,000 | 230,000 | 305,000 | 250,000 | 0 |

Cash flows | +50,000 | +180,00 | +75,000 | -55,000 | -250,000 |

5.

6. Comparing present values can be misleading when projects have different

economic lives and the projects are part of an ongoing business. For example, a machine that costs $100,000 per year to buy and lasts 5 years is not necessarily more expensive than a machine that costs $75,000 per year to buy but lasts only 3 years. Calculating the machines’ equivalent annual costs allows an unbiased comparison.

7. PV cost = 1.5 + .2 X 14.09 = $4.319 million. Equivalent annual cost = 4.319/14.09 = .306, or $306,000.

8. a. NPVA = $100,000; NPVB = $180,000

b. Equivalent cash flow of A = 100,000/1.736 5 $57,604; equivalent cash flow

of B = 180,000/2.487 = $72,376

c. Machine B.

9. Replace at end of 5 years ($80,000 > $72,376).

10. See the table below. We begin with the cash flows given in the text, Table 6.6, line 8, and utilize the following relationship from Chapter 3:

Real cash flow = nominal cash flow/(1 + inflation rate)t

Here, the nominal rate is 20%, the expected inflation rate is 10%, and the real rate is given by the following:

(1 + rnominal) | = (1 + rreal) (1 + inflation rate) |

1.20 | = (1 + rreal) (1.10) |

rreal |...