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FIN 305 Lecture Notes - Lecture 52: Tax Rate, Real Options Valuation, Cash Flow

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skykangaroo617
28 Apr 2019
School
CSU
Department
Finance
Course
FIN 305
Professor
Wendy Adele Usrey

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Document Summary

You expect to use your new boat for 10 years. After year 10 the salvage value of the boat is ,000 and the book value of the boat is ,000. What is the shut-down cash flow: ,000, ,000, ,500, - ,000 (40,000 25,000)*. 7 = 10,500. The cash outflows that occur as creditors are paid interest and principal, and stockholders are paid dividends. Go into computing the discount rate (chapter 9) The value of the cash inflows is reduced by the discount rate. Automatically included when you determine the npv of cash flows and/or in the hurdle rate of the irr decision rule. Don"t double count by then subtracting them from incremental cash flows. A right (not an obligation) to make a particular business decision. A manager is not obligated to take the action they will only do so if it increases the npv of the project.

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Related Questions

Problem 1

All Techniques- Decision among mutually exclusive investments. Pound industries is attempting to select the best of three mutually exclusive projects. The initial investment and after tax cash inflows associated with these projects are shown in the following table

Cash flow Project A Project B Project C

Initial investment (CF) $80,000 $110,000 $110,000

Cash inflows (CF), T=1 to 5 $25,000 $37,000 $38,500

Calculate the payback period for each project

Calculate the net present value (NPV) of each project, assuming that the fimrm has a cost of capital equal to 11%

Calculate the internal rate of return (IRR) for each project

Indicate which project you would recommend

A-the payback period of project A is ___years

the payback period of project B is ___years

the payback period of project C is ___years

B-the NPV of project A is $____

the NPV of project B is $____

the NPV of project C is $____

C- The IRR of project A is _____

The IRR of project B is _____

The IRR of project C is _____

D- which project would you recommend?

Project A

Project B

Project C

Problem 2

IRR, investment life, and cash inflows Oak enterprise accepts projects earning more than the firms 15% cost of capital. Oak is currently considering a 10 year project that provides annual cash inflows of $50,000 and requires an initial investment of $328,300

Deter the IRR of the project is it acceptable

Assuming that the cash inflos continue to be $50,000 per year how many additional years would the flows have to continue to make the project acceptable (that is, to make it have an IRR of 15%?

A. the project IRR is ___%

Is the project acceptable?

Yes or no

B. assuming that the cash inflows continue to be $50,000 per year the number of additional years the flows would have to continue to make the project acceptable at the 15% discount rate is ____ additional years

C) with the given life, initial investment and cost of capital the minimum annual cash inflow that the firm should accept is $______

Scenario Information:
Assume that two gas stations are for sale with the following cash flows; CF1 is the Cash Flow in the first year, and CF2 is the Cash Flow in the second year. This is the time line and data used in calculating the Payback Period, Net Present Value, and Internal Rate of Return. The calculations are done for you. Your task is to select the best project and explain your decision. The methods are presented and the decision each indicates is given below.

Investment Sales Price CF1 CF2
Gas Station A $50,000 $0 $100,000
Gas Station B $50,000 $50,000 $25,000



Three (3) Capital Budgeting Methods are presented:

Payback Period: Gas Station A is paid back in 2 years; CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in one (1) year. According to the payback period, when given the choice between two mutually exclusive projects, the investment paid back in the shortest time is selected.

Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%:
NPVgas station A = $100,000/(1+.10)2 - $50,000 = $32,644
NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2 - $50,000 = $16,115

Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station A is 41.421%.; for Station B, 36.602.

Summary of the Three (3) Methods:

Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A.

Under the NPV criteria, however, the decision favors gas station A, as it has the higher net present value. NPV is a measure of the value of the investment.

The IRR method favors Gas Station A. as it has a higher return, exceeding the cost of funds (10%) by the highest return.

Required:
Compare the results of the three (3) methods by quality of information for decision making. Using what you have learned about the three (3) methods, identify the best project by the criteria of long term increase in value. Convey your understanding of the Time Value of Money principles used or not used in the three (3) methods.

Scenario Information:
Assume that two gas stations are for sale with the following cash flows; CF1 is the Cash Flow in the first year, and CF2 is the Cash Flow in the second year. This is the time line and data used in calculating the Payback Period, Net Present Value, and Internal Rate of Return. The calculations are done for you. Your task is to select the best project and explain your decision. The methods are presented and the decision each indicates is given below.

Investment Sales Price CF1 CF2
Gas Station A $50,000 $0 $100,000
Gas Station B $50,000 $50,000 $25,000



Three (3) Capital Budgeting Methods are presented:

Payback Period: Gas Station A is paid back in 2 years; CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in one (1) year. According to the payback period, when given the choice between two mutually exclusive projects, the investment paid back in the shortest time is selected.

Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%:
NPVgas station A = $100,000/(1+.10)2 - $50,000 = $32,644
NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2 - $50,000 = $16,115

Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station A is 41.421%.; for Station B, 36.602.

Summary of the Three (3) Methods:

Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A.

Under the NPV criteria, however, the decision favors gas station A, as it has the higher net present value. NPV is a measure of the value of the investment.

The IRR method favors Gas Station A. as it has a higher return, exceeding the cost of funds (10%) by the highest