Final Exam REVIEW – Answers

Question 1

A major software company, Megasoft, is considering adding one more product to its product line. The
programming and marketing departments have come up with the following information for two potential
products the company can develop.

Product A:

This product will take 2 years to develop. The project starts in Year 0 with costs of $100,000 in Year 0
and $ 50,000 in Year 1. Benefits in years 2, 3 and 4 are expected to be $100,000 per year.

Product B:

This product will only take a year (Yr 0) to develop, at a cost of $120,000. Benefits in years 1-4 is
expected to be $60,000 per year.

Assuming the company uses a 5 – year planning horizon, which product should Megasoft initiate a
project to develop?

(Assume the discount rate is 20%)

(Round up to 2 decimal places)

Question 1 - Answer

Year 0 Year 1 Year 2 Year 3 Year 4

Product A
Cash flow ($100,000.00) ($50,000.00) $100,000.00 $100,000.00 $100,000.00
Discount Factor 1.0000 0.8333 0.6944 0.5787 0.4823
Present Value ($100,000.00) ($41,665.00) $69,440.00 $57,870.00 $48,230.00
NPV $33,875.00

Product B
Cash flow ($120,000.00) $60,000.00 $60,000.00 $60,000.00 $60,000.00
Discount Factor 1.0000 0.8333 0.6944 0.5787 0.4823
Present Value ($120,000.00) $49,998.00 $41,664.00 $34,722.00 $28,938.00
NPV $35,322.00

Megasoft should initiate Project B as the NPV is higher for Product B.

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Question 2

What is the net present value of a project with the following cash flows and a required return of 12%:

Year Cash Flow

0 ($ 28,900)
1 $12,450
2 $19,630
3 $ 2,750

Question 2 - Answer

Year Cash Flow Discount PV

Factor
0 ($28,900) 1 ($28,900.00)
1 $12,450 0.8929 $11,116.61
2 $19,630 0.7972 $15,649.04
3 $2,750 0.7118 $1,957.45
NPV ($176.91)

Question 3

What is the net present value of a project that has an initial cash outflow of $12,670 and the following
cash inflows? The required return is 11%

Year Inflows
0 $ 4,375
1 $0
2 $ 8,750
3 $ 4,100

Question 3 - Answer

Year Inflows Outflows Net Discount PV

Cashflow Factor
0 $4,375 -12670 ($8,295) 1 ($8,295)
1 $0 $0 0.9009 $0
2 $8,750 $8,750 0.8116 $7,102
3 $4,100 $4,100 0.7312 $2,998
NPV $1,804

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Question 4

A project will produce cash inflows of $1,750 a year for four years. The project initially costs $10,600 to
get started. In year five, the project will be closed and as a result should produce a cash inflow of
$8,500. What is the net present value of this project if the discount rate is 14%?

Question 4 - Answer

Year Cash Flow Discount PV

Factor
0 ($10,600) 1 ($10,600.00)
1-4 $1,750 2.9137 $5,098.98
5 $8,500 0.5194 $4,414.90
NPV ($1,086.13)

Question 5

You are considering the following two mutually exclusive projects. The required rate of return is 11%
for project A and 10 percent for project B. Which project should you accept and why?

Year Project A Project B

0 ($ 48,000) ($ 126,900)
1 $ 18,400 $ 69,700
2 $ 31,300 $ 80,900
3 $ 11,700 $0

Question 5 - Answer

Year Project A Project B Discount Disount PV - PV -

Factor Factor Project A Project B
(@ 11%) (10%)
0 ($48,000) ($126,900) 1 1 ($48,000) ($126,900)
1 $18,400 $69,700 0.9009 0.9091 $16,577 $63,364
2 $31,300 $80,900 0.8116 0.8264 $25,403 $66,856
3 $11,700 $0 0.7312 0.7513 $8,555 $0
NPV $2,535 $3,320

Since the NPV of Project B is higher than the NPV of Project A; Project B will be accepted.

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Question 6

You are considering two mutually exclusive projects with the following cash flows. Will your choice
between the two projects differ if the required rate of return is 8% rather than 11%? If so, what should
you do?

Year Project A Project B

0 ($ 240,000) ($ 198,000)
1 $0 $ 110,800
2 $0 $ 82,500
3 $ 325,000 $ 45,000

Question 6 - Answer

Year Project A Project B Discount PV - Project A PV - Project B

Factor (@ 8%)

0 ($240,000) ($198,000) 1 ($240,000) ($198,000)

1 $0 $110,800 0.9259 $0 $102,590
2 $0 $82,500 0.8573 $0 $70,727
3 $325,000 $45,000 0.7938 $257,985 $35,721
NPV $17,985 $11,038

Year Project A Project B Discount PV - Project A PV - Project B

Factor (@
11%)
0 ($240,000) ($198,000) 1 ($240,000) ($198,000)
1 $0 $110,800 0.9009 $0 $99,820
2 $0 $82,500 0.8116 $0 $66,957
3 $325,000 $45,000 0.7312 $237,640 $32,904
NPV ($2,360) $1,681

Yes, our decision will change; at 8%, project A has a higher NPV, but at 11% project B has higher NPV.

Question 7

A project will produce an operating cash flow of $7,300 a year for three years. The initial cash
investments in the project will $ 11,600. The net after-tax salvage value is estimated at $3,500 and will
be receiving during the last year of the project’s life. What is the present value of the project if the
required rate of return is 11%?

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Question 7 - Answer

Year Outflows Inflows Salvage Value Net Disount PV

Cashflow Rate
0 ($11,600) ($11,600) 1 -
11,600.00
1 $7,300 $7,300 0.9009 6,576.57
2 $7,300 $7,300 0.8116 5,924.68
3 $7,300 $3,500 $10,800 0.7312 7,896.96
NPV 8,798.21

Question 8

A project is expected to create an operating cash flow of $22,500 a year for three years. The initial cost
of the fixed assets is $ 50,000. These assets will be worthless at the end of the project. An additional
$3,000 of net working capital will be required throughout the life of the project. What is the project’s net
present value if the required rate of return is 10%?

Question 8 – Answer (PLEASE IGNORE THIS QUESTION AS THIS IS BEYOND THE SCOPE
OF OUR COURSE)

Year Outflows Inflows Salvage Value Net Disount PV

Cashflow Rate
0 ($53,000) ($53,000) 1 -53,000.00
1 $0 $22,500 $22,500 0.9091 20,454.75
2 $0 $22,500 $22,500 0.8264 18,594.00
3 $25,500 $0 $25,500 0.7513 19,158.15
NPV 5,206.90

Question 9

Woatich Windmill Company is considering a project that calls for an initial cash outlay of $50,000. The
expected net cash inflows from the project are $7,791 for each of 10 years. What is the IRR of the
project?

Question 9 - Answer

PV Factor = 50,000 / 7791 = 6.41

Refer to the Present Value Annuity Table (at 10 years)

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IRR = 9%

Question 10

Kool Inc. purchased a machine that will be used to produce nylon belt pouches:

Discount rate: 20%

Cost of machine: $75,000
Life: 5 Years
Salvage Value: $2,000
Maintenance Required: $10,000 at the end of the third year

Production and sales: 26,000 pouches per year

Sales price per pouch $2.75
Direct material $ 0.70
Variable labor and overhead cost $ 1.05

What is the NPV?

Question 10 - Answer

t0 t1 t2 t3 t4 t5 NPV
Cost of the ($75,000)
machine
Salvage value $2,000
Maintenance -10000
Cash receipt $26,000 $26,000 $26,000 $26,000 $26,000
Net cashflow ($75,000) $26,000 $26,000 $16,000 $26,000 $28,000
PV Factor (@ 1.0000 0.8333 0.6944 0.5787 0.4823 0.4019
20%)
PV ($75,000.00) $21,665.80 $18,054.40 $9,259.20 $12,539.80 $11,253.20 ($2,227.60)

Question 11

You have four projects from which to choose one. Project “Apple” is being done over a six year period
and has a net present value (NPV) of $70,000. Project “Berry” is being done over a three year period
and has an NPV of $30,000. Project “Android” is being done over a five year period and has an NPV of
$40,000. Project “Goggle” is being done over a one year period and has an NPV of $60,000. Which
project would you choose?

Question 11 - Answer

Project “Apple”; when calculating the NPV, time value of money is already taken into account.

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Question 12

The Thurston Animal Clinic is considering the acquisition of an X-ray machine that could be used to
diagnose injuries in large animals. The machine would cost $200,000 and have an expected life of
fifteen years with no salvage value. The annual cash operating costs of the machine are estimated at
$18,000. The manager of the clinic uncertain as to how much the new machine would increase annual
cash revenues.

Assuming the clinic’s cost of capital is 16 percent; compute the minimum amount cash receipts would
need to increase to induce the manager to purchase the new machine?

(A) $ 53,871 (B) $ 35,871 (C) $ 200,000 (D) $ 0

Question 12 - Answer

(A) $53,871
The minimum increase in cash receipts should be at-least equal the capital and operating cost (cash
outflow) due to the purchase of the X-ray machine. Let’s assume the minimum increase in cash receipt
as “X”

Hence, Present value of the cash inflow (increase in cash receipts)

= PV Factor x X
= 5.5755 x X

Therefore,
Present Value of Cash Outflow = Cash Inflow
200,000 + PV Factor x 18,000 = 5.5755 x X
200,000 + 5.5755 x 18,000 = 5.5755X
300,359 = 5.5755X
X = 300,359 / 5.5755
X = 53,871

Question 13

Based on the following information, what would be your “cost baseline”?

Project cost: $1,750
Contingency reserve: $105
Management reserve: $68

Question 13 - Answer

Cost Baseline = Project Cost + Contingency Reserve = 1750 + 105 = $1,855

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Question 14

Kool DJ Services have budget constraints and have to choose from one of the two projects identified as
below:

Project 1: Renovate the studio, which will have an increase in revenue by $ 120,000
Project 2: Replenish new equipments, which will have an increase in revenue by $ 100,000

Given this choice, the owner of the business Mr. Kool, chose to proceed with Project 1

What is the opportunity cost?

Question 14 - Answer

Opportunity lost is Project 2 and hence the Opportunity Cost is $100,000

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