ACC 406 Lecture Notes - Lecture 1: Net Present Value, Opportunity Cost

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graymule938

16 Dec 2017

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Discounted payback: number of periods before the pv of prospective cash flows equal or exceed the initial investment. Calculating the rate of return for long-lived projects. *how to calculate irr if the project generates cash flows in several periods. This is simply done through trial and error. With a discount rate, we have a npv of +148,000. With a discount rate of 50%, the npv is -. Here we see that when we lend 100, we get 150 back with project j, producing an irr of +50. K involves getting now, and paying 150 late, producing an irr of +50. However, j has a positive npv, while k is negative. Suppose we go back to buying the building example. You have two options: buy at 350k, sell after 1-year at 400k, rent out for 3 years at annum, sell at end of third year for 450k.

Related Questions

1. Understand how to use EXCEL Spreadsheet
(a) Develop proforma Income Statement Using ExcelSpreadsheet
(b) Compute Net Project Cashflows,NPV, and IRR
(c) Developproblem-solving and critical thinking skills
	and make long-term investment decisions

1) LifePeriod of the Equipment = 4 years			8) Sales for first year (1)			$200,000
2) Newequipment cost		$(200,000)	9) Sales increase per year			5%
3)Equipment ship & install cost		$(35,000)	10) Operating cost (60% of Sales)			$(120,000)
4) Relatedstart up cost		$(5,000)	(as a percent of sales in Year 1)			-60%
5)Inventory increase		$25,000	11) Depreciation (Straight Line)/YR			$(60,000)
6) AccountsPayable increase		$5,000	12) Marginal Corporate Tax Rate (T)			21%
7) Equip.salvage value before tax		$15,000	13) Cost of Capital (Discount Rate)			10%



ESTIMATING Initial Outlay (Cash Flow, CFo, T= 0)

		CF0	CF1	CF2	CF3	CF4
Year		0	1	2	3	4
Investments:
1)Equipment cost
2) Shippingand Install cost
3) Start upexpenses
Total Basis Cost (1+2+3)
4) Net Working Capital
Total Initial Outlay

Operations:
Revenue
OperatingCost
Depreciation
EBIT
Taxes
Net Income

Addback Depreciation

Total Operating Cash Flow			XXXXX	XXXXX	XXXXX	XXXXX

Terminal:
1) Changein net WC			$-	$-	$-	$20,000
2) Salvagevalue (after tax)		Salvage Value Before Tax (1-T)				XXXXX
Total						XXXXX

Project Net Cash Flows		$-	$-	$-	$-	$

NPV =		IRR =			Payback=

Q#1	Would you accept the project based on NPV, IRR?
	Would you accept the project based on Payback rule if projectcut-off
	is 3years?
Q#2 Impact of 2017 Tax Cut Acton Net Income, Cash Flows and
	Capital Budgeting (Investment ) Decisions
(a)	Estimate NPV, IRR and Payback Period of the project if equipment isfully
	depreciated in first year and tax rate equalsto 21%. Would you
	accept or reject the project?
(b)	As a CFO of the firm, which of the above two scenario(a) or (b)
	would you choose? Why?
Q#3 How would you explain to your CEOwhat NPV means?
Q#4 What are advantages anddisadvantages of using only Payback method?
Q#5 What are advantages and disadvantages of usingNPV versus IRR?
Q#6 Explain the difference between independent projectsand mutually exclusive projects.
	When you are confronted with Mutually Exclusive Projects and havecoflicts
	with NPV and IRR results, which criterion would you use (NPV orIRR) and why? *****SHOW WORK PLEASE !!!!

mauvespider741

Just yesterday I posted a key question as to why the statelottery might hypothetically offer you an upfront lump-sum paymentof $50 million or an ongoing annuity of a $5 million check eachyear for 20 years (totaling $100 million in checks). Remember thatthis was just my simplified hypothetical example. A few peopleattempted the answer to this further above, but here's what'sreally going on...it has to do with Net Present Value (NPV). It'sbecause future-year dollars are worth less, and the further you gointo the future, the less those dollars are worth in terms oftoday's dollars. And that is why, when financial analysts look at adecision involving multi-year cash flows, they will use discountfactors to convert all of the future-year dollars to present value(i.e., this year's dollars) and add them up to yield the NPV of allof the amounts to put a final answer in terms of today's value.Where do these discount factors come from? They're derived from thereciprocal of the famous compound interest formula, but you justneed to go and look at two tables in your textbook in Chapter 12,Appendix 12A, Table A (present value of $1 due in n periods) andTable B (present value of an annuity of $1 per period). Class, Icannot stress to you enough how widely-used this concept is, andthe importance of understanding how these discount factors areapplied to solve for net present value (NPV) and a related metric,internal rate of return (IRR). You will likely need to read, andreread, Chapter 12 and closely walk through some textbook exampleswhere each year's cash flows are multiplied by the appropriatediscount factor to convert all of that money into this year'sdollars (present value). We are surrounded by this financialanalysis methodology when faced with a decision on a lotterypayout, a retirement payout (lump sum versus annuity), and many ofour states and cities right now are dealing with issues relating tothe calculation of NPV in assessing whether they currently haveenough money in the appropriate accounts to meet the futureretirement payment obligations they've made to their publicemployees. This is an economic issue that has been on the brink ofexploding for a long time (don't take my word for it, it's beendiscussed in multiple articles in the NY Times, Wall StreetJournal, The Economist), but I'm not going to add all of that intothis discussion here. Let's learn to walk before we try to run.Would you like to see how the lottery payouts I described would bemultiplied by each year's financial discount factor? Just take alook at my attached Excel workbook, and note that there are threetabs: the first assumed a 0% cost of capital (no financialdiscounting done), the second assumed a 5% cost of capital, and thethird sheet inserted a 10% cost of capital. You'll see how thesedifferent interest rates changed the discount factor multipliersand ultimately changed the NPV of each alternative (the value ofthe lump sum or the annuity, all shown in present value). Also,this example just shows money moving one way (i.e., to the state,it's cash out of their pocket...to the lottery winner, it's cashinto their pocket). In many NPV and IRR examples, money will moveboth ways over multiple years...cash flows that are expenses orinvestments are outflows and are shown as negative, while revenuesor other incoming money are inflows and are shown as positive.Please look closely at my attached Excel workbook (all three tabs)and also walk through all of the examples in the chapter showinghow to do NPV and IRR problems. There are also examples in the textof simpler metrics including payback period and accounting rate ofreturn. It's typically very hard stuff for students to master. Now,for those of you who've looked at the chapter examples, maybeyou've figured this out already:

1. What is the key difference between Tables A and B in Chapter12, Appendix 12A, and how and when are each of them used in ananalysis?

2. What do we mean by âYear 0â in a financial analysis? Whatvalue do we use for the discount factor or multiplier for the cashflow in Year 0 of a financial analysis?

QUESTION 1

Which of the following statements is correct regarding thepayback method as a capital budgeting technique?

		The payback method considers the time value of money.
		An advantage of the payback method is that it indicates if aninvestment will be profitable.
		The payback method provides the years needed to recoup theinvestment in a project.
		Payback is calculated by dividing the annual cash inflows by thenet investment.

0.625 points

QUESTION 2

Taxes are not an important consideration indeveloping cash flow assessments.

True

False

0.625 points

QUESTION 3

USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT (2)QUESTIONS:

Parkways Inc. is considering the purchase of a new machine. Themachine will cost $60,000 to purchase and will generate $15,000 ofcash revenues per year for the next 8 years. The machine will cost$1,000 per year to operate & maintain. At the end of it'suseful life, it has an estimated salvage value of $5,000. Parkwaysrequires a minimum rate of return of 14% for this class of asset.Determine the Net Present Value of this investment proposal.

PV of $1 (14%, 8n) is .351; PVOA (14%, 8n) is 4.639

		$6,701
		$57,000
		$1,166
		$0

0.625 points

QUESTION 4

Sun Devil Corporation is adding a new product line that willrequire an investment of $138,000. The product line is estimated togenerate net cash flows of $25,000 the first year, $23,000 thesecond year, and $18,000 each year thereafter for ten more years.What is the payback period?

		7.26
		5.52
		7.00
		7.67

0.625 points

QUESTION 5

Sparky Company invested in an asset with a useful life of 5years. The companys required rate of return is 10% for this classof asset. The net cash flows are estimated to be $7,610 per yearfor the next 5 years and no salvage value is anticipated.

If the asset generates a positive net present value of $2,000,what was the amount of the original investment? (Roundyour answer to the nearest whole dollar. Do not use $signs or commas in recording youranswer. EXAMPLE: If you answer is $22,516,enter your answer as 22516).

Present Value of $1
Periods	10%	12%	14%
5	.621	.567	.519
8	.467	.404	.351
10	.386	.322	.270
Present Value of Ordinary Annuity
Periods	10%	12%	14%
5	3.791	3.605	3.433
8	5.335	4.968	4.639
10	6.145	5.650	5.216

0.625 points

QUESTION 6

Suppose Whole Foods is considering investing inwarehouse-management software that costs $500,000, has $60,000residual value and should lead to cash cost savings of $130,000 peryear for its five-year life. Determine the NPV of the investment ifmanagement uses a 12% discount rate. (Round to the nearest wholenumber for your final answer. When recording your answer, do notuse $ dollar signs or commas. EXAMPLE: If you answer is $12,251,enter 12251)

Present Value of $1
Periods	10%	12%	14%
5	.621	.567	.519
8	.467	.404	.351
10	.386	.322	.270
Present Value of Ordinary Annuity
Periods	10%	12%	14%
5	3.791	3.605	3.433
8	5.335	4.968	4.639
10	6.145	5.650	5.216

0.625 points

QUESTION 7

ABC, Corporation is looking to purchase a new piece of equipmentfor $121,505. The equipment has a useful life of 8 years and noexpected salvage value.

The minimum desired rate of return is 10%. ABC is uncertain asto the annual net cash flows the equipment will generate.

What is the minimum annual net cashflow ABC must achieve in order to justify the purchase of this newequipment?

(Round your answer to the nearest whole dollar. Do not use $dollar signs or commas when recording your answer.)

Present Value of $1
Periods	10%	12%	14%
5	.621	.567	.519
8	.467	.404	.351
10	.386	.322	.270
Present Value of Ordinary Annuity
Periods	10%	12%	14%
5	3.791	3.605	3.433
8	5.335	4.968	4.639
10	6.145	5.650	5.216

0.625 points

QUESTION 8

Sparky Company is considering the replacement of an old machinewith the purchase of a new piece of production equipment that willreduce labor and maintenance costs by $45,000 peryear. If Sparky purchases the new machine, the companywill sell the old equipment for an estimated $20,000 salvage value.Data related to the new machine follows:

InitialInvestment $300,000

UsefulLife 10years

Salvagevalue (newmachine) $30,000

HurdleRate 12%

Assume all cash flows occur at the end of the year and ignoreincome taxes. Calculate the net present value of theinvestment in the new machine. (Round your answer to the nearestwhole dollar. If you have a negative NPV, record youranswer using () parenthesis. EXAMPLE: If yourNPV is ($2,000), enter your answer as (2000).

Present Value of $1
Periods	10%	12%	14%
5	.621	.567	.519
8	.467	.404	.351
10	.386	.322	.270
Present Value of Ordinary Annuity
Periods	10%	12%	14%
5	3.791	3.605	3.433
8	5.335	4.968	4.639
10	6.145	5.650	5.216

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ACC 406 Lecture Notes - Lecture 1: Net Present Value, Opportunity Cost

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