Question

 

1 Knowles Music Inc. wants to expand its business and wants to use some debt capital to help finance that expansion. If it borrows $150,000.00 for 5 years, and the lender says the quarterly payments will be $8,855.74, what is the interest rate for this loan? (Compute to 4 decimal places).

Answer:N = 5 x 4 = 20 PV = 150,000PMT = -8,855.74

Compute I = 1.637499 x 4 = 6.549996%. (how to get these number)

2.Howertons Corp. is considering offering a new product which would cost $2.6 million to develop, and the expected annual Free Cash Flows (in thousands of dollars) are: CF1 = $325; CF2 = $487; CF3 = $576; CF4 = $653; and CF5 = $210. If the company’s minimum required annual return is 18%, would this be a good investment?

Answer:NPV: $(1,195.6460) means Cost exceeds GPV

IRR: (4.681239) = (4.68%) which is lower than 18%This is not a good investment because NPV is less than $0(When NPV is less than $0, this means the Upfront Cost exceeds the future expected GPV benefit)

3 How much would the upfront cost need to be in order for the Q2 project be a good investment?

Answer:I = 18 CF0 = 0

CF1 thru CF5 are the same

Compute NPV: $1,404.354 (no more than $1.404 mil.)

Answer 1

You need to use a financial calculator to solve all the 3 problems.

1. In the financial calculator enter the numbers in the calculator given in the order.

N = no. of quarters = 5*4 =20; PV = loan amount = 150,000; PMT = quarterly payments = -8,855.74 > CPT = compute > I/Y = quarterly interest rate = 1.637499%

in the calculator input 20 and then press N button. next input 150,000 and press PV button. now input -8,855.74 and press PMT button. now press CPT button and then press I/Y button. calculator will display 1.637499.

this 1.637499% is quarterly interest rate. to make it annual, we need to multiply it by 4 because there are 4 quarters in a year.

annual interest rate = 1.637499%*4 = 6.549996%

2. again you need to use financial calculator for this problem.

Press CF and 2ND key in the calculator and then press CE/C key to clear CF register. now you'll see CF₀= 0. input -2,600,000 and press enter and then down arrow key. this amount we entered as negative value because it's a cash outflow.

in C01 input 325,000 and press enter and down arrow key. next you'll see F01= 1.00. leave it as it is and press down arrow key. now you'll see C02. enter 487,000 press enter and down arrow key. next you'll see F02= 1.00. leave it as it is and press down arrow key.

Enter year 3,4 and 5 cash flow of 576,000, 653,000 and 210,000 in C03, C04 and C05 and leave F03 and F04 as it is. when you get F05= 1.00 then press NPV key. you'll get I = 0.00. input 18 and press enter followed by down arrow key. you'll get NPV= 0.00. press CPT key and you'll get NPV = -1,195,646. next press IRR key. you will get IRR= -4.681239 or -4.68%.

this would not be a good investment because negative NPV indicates present value of expected annual Free Cash Flows is lower than initial cost or investment. negative NPV and IRR indicate project will make losses. IRR is the internal rate of return at which present value of expected annual Free Cash Flows is equal to initial cost or investment. so IRR should be greater than minimum required annual return.

3. you need to use financial calculator for this problem also.

Press CF and 2ND key in the calculator and then press CE/C key to clear CF register. now you'll see CF₀= 0. input 0 and press enter and then down arrow key.

in C01 input 325,000 and press enter and down arrow key. next you'll see F01= 1.00. leave it as it is and press down arrow key. now you'll see C02. enter 487,000 press enter and down arrow key. next you'll see F02= 1.00. leave it as it is and press down arrow key.

Enter year 3,4 and 5 cash flow of 576,000, 653,000 and 210,000 in C03, C04 and C05 and leave F03 and F04 as it is. when you get F05= 1.00 then press NPV key. you'll get I = 0.00. input 18 and press enter followed by down arrow key. you'll get NPV= 1,404,354.

the upfront cost would not need to be greater than 1,404,354 in order for the Q2 project be a good investment.