DEVRY FIN 515 Week 3 Problem Set

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DEVRY FIN 515 Week 3 Problem Set

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• FIN 515 Week 3 Problem Set
• Chapter 7 (pages 225228)
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• 1. Your brother wants to borrow 10,000 from you.
  He has offered to pay you back 12,000 in a year.
  If the cost of capital of this investment
  opportunity is 10, what is its NPV? Should you
  undertake the investment opportunity? Calculate
  the IRR and use it to determine the maximum
  deviation allowable in the cost of capital
  estimate to leave the decision unchanged.
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• 8. You are considering an investment in a clothes
  distributor. The company needs 100,000 today and
  expects to repay you 120,000 in a year from now.
  What is the IRR of this investment opportunity?
  Given the riskiness of the investment
  opportunity, your cost of capital is 20. What
  does the IRR rule say about whether you should
  invest?
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• 19. You are a real estate agent thinking of
  placing a sign advertising your services at a
  local bus stop. The sign will cost 5,000 and
  will be posted for one year. You expect that it
  will generate additional revenue of 500 per
  month. What is the payback period?
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21. You are deciding between two mutually
exclusive investment opportunities. Both require
the same initial investment of 10 million.
Investment A will generate 2 million per year
(starting at the end of the first year) in
perpetuity. Investment B will generate 1.5
million at the end of the first year and its
revenues will grow at 2 per year for every year
after that. a. Which investment has the higher
IRR?b. Which investment has the higher NPV when
the cost of capital is 7?c. In this case, for
what values of the cost of capital does picking
the higher IRR give the correct answer as to
which investment is the best opportunity?Chapter
8 (260262) 1. Pisa Pizza, a seller of frozen
pizza, is considering introducing a healthier
version of its pizza that will be low in
cholesterol and contain no trans fats. The firm
expects that sales of the new pizza will be 20
million per year. While many of these sales will
be to new customers, Pisa Pizza estimates that
40 will come from customers who switch to the
new, healthier pizza instead of buying the
original version. a. Assume customers will
spend the same amount on either version. What
level of incremental sales is associated with
introducing the new pizza?  
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b. Suppose that 50 of the customers who will
switch from Pisa Pizzas original pizza to its
healthier pizza will switch to another brand if
Pisa Pizza does not introduce a healthier pizza.
What level of incremental sales is associated
with introducing the new pizza in this
case? 6. Cellular Access, Inc. is a cellular
telephone service provider that reported net
income of 250 million for the most recent fiscal
year. The firm had depreciation expenses of 100
million, capital expenditures of 200 million,
and no interest expenses. Working capital
increased by 10 million. Calculate the free cash
flow for Cellular Access for the most recent
fiscal year. 12. A bicycle manufacturer currently
produces 300,000 units a year and expects output
levels to remain steady in the future. It buys
chains from an outside supplier at a price of 2
a chain. The plant manager believes that it would
be cheaper to make these chains rather than buy
them. Direct in-house production costs are
estimated to be only 1.50 per chain. The
necessary machinery would cost 250,000 and would
be obsolete after 10 years. This investment could
be depreciated to zero for tax purposes using a
10-year straight-line depreciation schedule. The
plant manager estimates that the operation would
require 50,000 of inventory and other working
capital upfront (year 0), but argues that this
sum can be ignored because it is recoverable at
the end of the 10 years. Expected proceeds from
scrapping the machinery after 10 years are
20,000. If the company pays tax at a rate of 35
and the opportunity cost of capital is 15, what
is the net present value of the decision to
produce the chains in-house instead of purchasing
them from the supplier?