Principles of Finance
Sample Third Quiz
Do all the problems. Include calculations and/or explanations in your answers wherever appropriate. More credit will be given for correct reasoning than for correct arithmetic.
1. Alpha Co. is investigating two mutually exclusive projects A and B with common cost of capital k = 6%.
here A: -$5,000, $1,646, $1,646, $1,646, $1,646 NPV = $704 IRR = 12%
B: -$2,000, $701, $701, $701, $701. NPV = $429 IRR = 15%
(a) Calculate the NPV’s and IRR’s for both. Is each one by itself acceptable?
(b) Sketch the NPV profiles on a common set of axes.
(c) Explain which is preferred at k = 6%. Which would be preferred at k = 11%? A at 6%, B at 11%
(d) Why are these answers in part (c) different?
2. Beta Co. is looking at Project C with cost of capital k = 7%.
C: $3,000, -$945, -$945, -$945, -$945.
IRR = 10% but this is a borrowing project with NPV = -$201
Sketch C’s NPV profile. Is it acceptable? Explain in both NPV and IRR terms.
3. We are thinking of buying a truck. It will cost $20,000 and be subject to a 10% investment tax credit. It falls in the SACRS (30%, 20%, 20%, 15%, 15%) class. Our tax rate is 30%.
(a) Write the depreciation schedule.
(b) We will sell the truck after four years for $5,000. What after-tax cash flow will result from the sale?
(c) The truck will save us $6,000 per year in expenses. Write all the cash flows for this project from purchase to sale.
4. Gamma Co. is looking at Project D with k = 7%.
D: -$3,000, $2,000, $4,000, $6,000, -$10,000
The spread sheet says the NPV = -$368 but IRR = 15%. Is Project D acceptable? It has a negative NPV but IRR > k. Explain.
5. I am planning on investing for retirement. I estimate that I will need $100,000 per year for twenty years. I expect to earn 7% while accumulating and 3% in retirement. I am now 25 expecting to retire at 70 and have nothing in the plan yet, and from this year I will be contributing equal annual amounts.
. (a) How big must those contributions be?
. (b) I started on that plan ten years ago and am now 35 and have $80,000 in the plan. If I still want the $100,000 per year, what contributions should I make?
. (c) The week after making the calculation in part (b), a market crash causes me to lose 30% of my $80,000. If I go on making the contributions from part (b) and retire two years later, can I still expect at least the $100,000 per year?