Question

In: Finance

1. Hiram Finnegan Inc. is considering a capital investment project. This project will cost $10 million...

1. Hiram Finnegan Inc. is considering a capital investment project. This project will cost $10 million today. Managers expect that net cash flows will be $15 million at the end of year 1 and $40 million at the end of year 2. After year 2, the project will be finished. The appropriate annual discount rate for projects of this risk is 12% per year. What is the net present value of this project? Should the firm accept this project? (Choose the best answer.)

A. $55.0 mil.; accept because NPV > 0.

B. $35.3 mil.; accept because NPV > 0.

C. -$10.0 mil.; reject because NPV < 0.

D. -$45.0 mil.; reject because NPV < 0.

E. $45.3 mil.; accept because NPV > 0.

2. Diane Badame, a financial analyst at Kaufman & Broad, a real estate firm, has been asked to make a recommendation about whether Kaufman & Broad should invest in a piece of land that would cost $85,000 in cash today. The investment rate of return on similar alternative investments is 10% per year, compounded annually. Diane estimates that the land can be sold next year for $91,000. Assuming that her forecast is correct, what should she recommend, and why?

Hint: this problem is implicitly a one-period NPV problem.

A. Do not buy the land, because its present value is $86,842.25, which is greater than the purchase price.

B. Do not buy the land, because its present value is $82,727.27, which is less than the price.

C. Buy the land, because it will be worth $6,000 more in one year’s time, so Kaufman & Broad can sell it for a profit.

D. Buy the land, because its present value is $82,727.27, which is a bargain compared to $85,000.

Solutions

Expert Solution

Ans 1
i ii iii=i*ii
year Cash flow PVIF @ 12% present value
0 -10     1.0000        (10.0)
1 15     0.8929          13.4
2 40     0.7972          31.9
         35.3
NPV =          35.3 mil
correct answer is option : B. $35.3 mil.; accept because NPV > 0.
Ans 2
present value of land value after 1 year = 91000/1.1
82727.27
Present value of land after 1 year is lower than its curret value.
therefore correct answer is option :
B. Do not buy the land, because its present value is $82,727.27, which is less than the price.

jeff jeffy answered 9 months ago
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