Exam 8: Investment Decision Rules

Mary is in contract negotiations with a publishing house for her new novel.She has two options.She may be paid $100,000 up front,and receive royalties that are expected to total $26,000 at the end of each of the next five years.Alternatively,she can receive $200,000 up front and no royalties.Which of the following investment rules would indicate that she should take the former deal,given a discount rate of 8%?

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years.The winner calculates the internal rate of return (IRR)of taking the money at the end of each year and,estimating that the discount rate across this period will be 6%,decides to take the money at the end of each year.Was her decision correct?

A local government awards a landscaping company a contract worth $1.2 million per year for five years for maintaining public parks.The landscaping company will need to buy some new machinery before they can take on the contract.If the cost of capital is 7%,what is the most that this equipment could cost if the contract is to be worthwhile for the landscaping company?

A small department store in a mall has the opportunity to rent an additional 20,000 square feet of space for five years.It can divide up this space between the above new departments.Each department will require a different amount of space,and each department is expected to make a yearly profit as shown,for each of the next five years.The discount rate is 10%.Based on this information,what departments should be added?

Preference for cash today versus cash in the future in part determines net present value (NPV).

Most corporations measure the value of a project in terms of which of the following?

Use the table for the question(s)below. Consider the following two projects: -Assume that projects Alpha and Beta are mutually exclusive.The correct investment decision and the best rational for that decision is to:

A lawn maintenance company compares two ride-on mowers-the Excelsior,which has an expected working-life of six years,and the Grassassinator,which has a working life of four years.After examining the equivalent annual annuities of each mower,the company decides to purchase the Excelsior.Which of the following,if TRUE,would be most likely to make them change that decision?

What is the general shape of the net present value (NPV)profile?

You are considering an investment opportunity that will cost you $20,000 up front,but return $5,000 per year for the next 10 years.What is the IRR for this investment?

An investor has a budget of $10 million.He can invest in the projects shown above.If the cost of capital is 6%,what investment or investments should he make?

You are considering an investment opportunity that will cost you $50,000 up front,and return two payments of $30,000,with the first payment 4 years from today.What is the IRR for this investment?

Use the information for the question(s)below. -If WiseGuy Inc.uses the payback period rule to choose projects,which of the projects will rank highest?

Use the information for the question(s)below. Your firm is preparing to open a new retail strip mall and you have multiple businesses that would like lease space in it.Each business will pay a fixed amount of rent each month plus a percentage of the gross sales generated each month.The cash flows from each of the businesses has approximately the same amount of risk.The business names,square footage requirements,and monthly expected cash flows for each of the businesses that would like to lease space in your strip mall are provided below: -If your new strip mall will have 15,000 square feet of retail space available to be leased,to which businesses should you lease and why?

An investor is considering the two investments shown above.Which of the following statements about these investments is TRUE?

You wish to buy a new lawnmower and you are deciding between a gas powered lawn mower and an electric mower.The electric mower costs $275 more than the gas mower,but you estimate that it will save you $40 per year by using cheaper electricity relative to gasoline.If the expected lifetime of both mowers is 30 years,and the cost of capital of 5%,what is the NPV of getting an electric mower instead of a gas mower?

The cash flows for four projects are shown below,along with the cost of capital for these projects.If these projects are mutually exclusive,which one should be taken?

An investor has the opportunity to invest in four new retail stores.The amount that can be invested in each store,along with the expected cash flow at the end of the first year,the growth rate of the concern,and the cost of capital is shown for each case.It is assumed each investment will operate in perpetuity after the initial investment.Which investment should the investor choose?

Use the information for the question(s)below. -The owner of a hair salon spends $1,000,000 to renovate its premises,estimating that this will increase her cash flow by $220,000 per year.She constructs the above graph,which shows the net present value (NPV)as a function of the discount rate.At what dollar value should the NPV profile cross the vertical axis?

A company that creates education products is planning to create a suite of books to help customers prepare for high-stakes tests for entry into college and grad school.They have 33 in-house writers to create these books.Due to the expertise needed in creating this content it will not be possible to hire temporary writers within the planned time-frame.Which projects should be undertaken?