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# Finance: Net Present Value Methodology

financial solution.

Question 1

Select all the correct statement(s) from the below choices.

Managers should ignore sunk costs when deciding whether to continue a project or not.

Incidental effects, such as the impact of a branch store on the business of the main store, are important and should be considered.

We must deduct interest and dividend payments when calculating project cash flows.

We should form our investment decisions around average (not incremental) payoffs.

None of the above are correct statements.

Question 2

Economists expect the inflation to be 5% per year, and the nominal discount rate is 7.5% per year. George wants to find the real discount rate. What is the real discount rate?

Answer for Question 2

Question 3

Please use the following to answer questions 3 through 5. The Giraffe Corporation is considering two machines, A and B, which cost the same and are equally effective, but differ with respect to useful lifespan and operating costs. Machine A lasts for 3 years, while machine B lasts for 4 years. The cash outflows needed for operating the machines are given as below, in millions of dollars.

Machine t = 0 t = 1 t = 2 t = 3 t = 4

A -$10 -$2 -$2 -$2 (replace)

B -$9 -$4 -$4 -$4 -$4 (replace)

Neha is a manager at the Giraffe Corporation. She wants to choose the machine with the lowest equivalent annual cost (EAC), given that the opportunity cost of capital is 9% per year. What is the equivalent annual cost (EAC) of machine A, in millions of dollars? Please give answers correct to three decimal places. For example, if the answer is 2.1506 million, please enter 2.151.

Answer for Question 3

Question 4

What is the equivalent annual cost (EAC) for machine B, in millions of dollars? Please give answers correct to three decimal places. For example, if the answer is 2.1506 million, please enter 2.151.

Answer for Question 4

Question 5

Based on your calculations, which machine should Neha choose?

Machine A

Machine B

There is insufficient information to answer this question.

Question 6

Please use the following to answer questions 6 through 10. [Exam-type Question] Chioma works for the Furniture Company. She is evaluating a project to build a factory to manufacture designer chairs.

Item 20X2 20X3 20X4 20X5

Production (chairs) 3,100 3,500 4,000 4,150

Labor (hours) 500 700 900 950

Materials (units) 2,000 2,350 2,700 3,000

Today is 12/31/X1. The initial investment on 12/31/X1 is $500,000. The income tax the firm faces is 30%, and the firm uses straight-line depreciation. The salvage value of the initial investment on 12/31/X5 is $50,000. The firm expects to sell all the chairs it produces. The price that chairs sell for is $200 per chair on 12/31/X1, and this is expected to be constant over the next decade. Labor costs are $10 per hour on 12/31/X1 and rise at 5% per year. Materials cost $100 per unit on 12/31/X1 and grow at 2% per year. All revenue is received at the end of the year, and costs are also paid at the end of the year. For example, we use 12/31/X5 prices for calculating 20X5 revenues and costs. The firm has other lines of business that are profitable so any losses can be offset against these for tax purposes. All figures are in nominal terms. The nominal discount rate is 15% per year.

What is the labor cost per hour as of 12/31/X5? Please give answers to 3 decimal places. For example, if the answer is 7.3205, please enter 7.321.

Answer for Question 6

Question 7

What is the present value (PV) of the salvage value of the factory investment? Please give your answer to the nearest dollar. For example, if the answer is 975.55, please enter 976.

Answer for Question 7

Question 8

What is the total revenue from sales (price per chair times number of chairs) for the year 20X3? Please give your answer to the nearest dollar. For example, if the answer is 975.55, please enter 976.

Answer for Question 8

Question 9

What is the total production cost (total amount of labor + materials expenses) for the year 20X5? Please give your answer to the nearest dollar. For example, if the answer is 975.55, please enter 976.

Answer for Question 9

Question 10

What is the amount of the annual depreciation tax shield, under straight-line depreciation? Note that the tax code is written in nominal terms.

Please give your answer to the nearest dollar. For example, if the answer is 975.55, please enter 976.

Answer for Question 10

Question 11

Finally, what is the net present value (NPV) of the project?

Answer for Question 11