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Problem-1
Cash flows from two investment opportunities are given below.
| Year | CFA | CFB |
| 0 | ($1,000) | ($1,000) |
| 1 | $100 | $800 |
| 2 | $200 | $300 |
| 3 | $400 | $300 |
| 4 | $700 | $200 |
| 5 | $800 | $200 |
If the cost of capital is 10%, what is the NPV, IRR and Payback period of each investment? What is the appropriate investment choice if (i) the investments are mutually exclusive, or (ii) the investments are independent?
Problem-2
Automated Manufacturers must choose from the following two mutually exclusive investment opportunities:
| Opportunity | Expected life | NPV |
| A | 6 years | $2 million |
| B | 4 years | $1.5 million |
What is the appropriate decision if the firm’s cost of capital is 9%? Why?
Problem-3
Puffy Clouds, a maker of data storage products, is considering adding a new manufacturing facility. The new facility would be housed in an unused building that the firm bought 8 years ago for $600,000 and could be sold today for $2 million. The new facility would require the purchase of $50 million of equipment that would be depreciated straight line to a zero salvage value over a useful life of 5 years. However, the firm expects this equipment would have a scrap value of $250,000 at the end of its 5-year life. The firm would finance the equipment purchase with a five-year debt issue that would carry an interest rate of 5% p.a. The new facility would add $20 million to annual revenues, which are currently $100 million per year. The higher manufacturing efficiency of the new facility would reduce annual operating costs from 40% of revenues to 35% for both existing and new sales revenues. The new facility would require a $500,000 increase in net working capital, which would be recovered at the end of the project. The firm’s tax rate is 21% and the required rate of return is 8%. Calculate the NPV and IRR for the new facility.
Problem-4
ACB Inc. has 100,000 bonds outstanding that have 12 years of life remaining and carry a 10% coupon (paid semi-annually). The firm also has 8 million shares of preferred stock that pays a dividend of $2 per share. There are 50 million shares of common stock outstanding; the common stock has a beta of 1.5, the risk-free rate is 2% and the market risk premium is 6%. The bonds are currently trading at $1,447.12 each, preferred stock at $25 per share and common stock at $7.50 per share. If the tax rate is 21%, what is ACB’s WACC?
Problem-5
An all-equity firm is considering the projects shown as follows. The T-bill rate is 2 percent and the market risk premium is 6 percent. If the firm’s WACC is 12 percent, which of the four projects should be accepted? Why?
| Project | Expected return | Beta |
| A | 9% | 0.7 |
| B | 11% | 1.1 |
| C | 13% | 1.5 |
| D | 15% | 1.9 |
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