Finance Assignment

ADMS3530

Assignment #2 - Solutions

SU2010

Instructions:

1) This assignment is to be done individually. You must sign and submit the standard cover page supplied as the last page of this assignment.

2) Before you start, please read the note “Writing Style Required for ADMS3530 Assignments” posted on the course web site. Please stick to the writing guidelines suggested in the note.

3) This assignment is due in class in the week of July 26, 2010.

4) This assignment must be handwritten. Work that is too difficult to read due to messiness and poor handwriting will receive zero credit. You must show your work to receive full credit.

5) This assignment is worth a total of 100 marks.

6) Late assignments will not be accepted for any other reason.

7) Decimal places: please keep at least 4 in your calculations and 2 in your final answers.

Question 1 – NPV and Other Criteria (15 marks)

Project A costs $50,000 and returns $15,000 after-tax annually.

Project B costs $35,000 and returns $11,000 after-tax annually.

Both projects last five years and are mutually exclusive. There is no capital rationing and your opportunity cost of capital is 8%

a) Which project(s) should you accept under the NPV rule? (5 marks)

b) Which project(s) would you accept under the IRR rule? (5 marks)

c) Which project(s) would you accept using the discounted payback criteria if the firm requires that projects have a discounted payback of 4 years or less?

(5 marks)

SOLUTION

(a) Project A: NPV = $15,000 × PVAF(8%, 5) – $50,000 = $9,890.65

Project B: NPV = $11,000 × PVAF(8%, 5) – $35,000 = $8,919.81

Therefore based on NPV, choose Project A.

(not both as the projects are ”mutually-exclusive”)

(b) Using your calculator, find where NPV=0

i.e. To solve for Project A’s IRR: $50,000 = $15,000 × PVAF(IRR, 5)

(IRRA = 15.24%.

Project B’s IRR: $35,000 = $11,000 ×...