Exam 6: Making Investment Decisions With the Net Present Value Rule

Preferably, a financial analyst estimates cash flows for a project as

If the nominal interest rate is 7.5 percent and the inflation rate is 4.0 percent, what is the real interest rate?

Within the MACRS system of depreciation, most industrial equipment falls into the 10-15 year classes.

The equivalent annual cash-flow technique is primarily used whenever the lives of two different projects are the same.

The current market value of a previously purchased machine proposed for use in a project is an example of a(n)

RainMan Inc. is in the business of producing rain upon request. They must decide between two investment projects: a new airplane for seeding rain clouds or a new weather control machine built by Dr. Nutzbaum. The discount rate for the new airplane is 9 percent, while the discount rate for the weather machine is 39 percent (it happens to have higher market risk). Which investment should the company select and why? (Assume a 0 percent inflation rate and that projected costs do not change over time.)

Opportunity costs should not be included in project analysis, as they are missed opportunities.

Briefly discuss how tax reporting to governments versus shareholders is treated in countries like Japan.

By undertaking an analysis in real terms, the financial manager avoids having to forecast inflation.

The principal short-term assets are

A firm has a general-purpose machine, which has a book value of $300,000 and is worth $500,000 in the market. If the tax rate is 21 percent, what is the opportunity cost of using the machine in a project?

A piece of capital equipment costing $400,000 today has no (zero)salvage value at the end of five years. If straight-line depreciation is used, what is the book value of the equipment at the end of three years?

Your boss asked you to evaluate a project with an infinite life. Sales and costs project to $1,000 and $500 per year, respectively. (Assume sales and costs occur at the end of the year [i.e., profit of $500 at the end of year one]). There is no depreciation and the tax rate is 21 percent. The real required rate of return is 10 percent. The inflation rate is 4 percent and is expected to be 4 percent forever. Sales and costs will increase at the rate of inflation. If the project costs $3,000, what is the NPV?

Sunk costs are bygones (i.e., they are unaffected by the decision to accept or reject a project). They should therefore be ignored.

Depreciation expense acts as a tax shield in reducing taxes.

When evaluating mutually exclusive projects with positive NPV but different life spans, the proper technique to employ is the equivalent annual cash-flow approach.

One should consider net working capital (NWC)in project cash flows because

Briefly explain how the decision to replace an existing machine is made.

Germany allows firms to choose the depreciation method(s)of

A project requires an investment of $900 today. It can generate sales of $1,100 per year forever. Costs are $600 for the first year and will increase by 20 percent per year. (Assume all sales and costs occur at year-end [i.e., costs are $600 @ t = 1].)The project can be terminated at any time without cost. Ignore taxes and calculate the NPV of the project at a 12 percent discount rate.