Question

1) A company has a minimum required rate of return of 8%. It is considering investing in a project that costs $75,930 and is expected to generate cash inflows of $30,000 each year for three years. The approximate internal rate of return on this project is

	A.	8%.
	B.	9%.
	C.	10%.
	D.	cannot be approximated

2)

A company has a minimum required rate of return of 9%. It is considering investing in a project which costs $140,000 and is expected to generate cash inflows of $56,000 at the end of each year for three years. The net present value of this project is (use the tables in Appendix D)

	A.	$141,736.
	B.	$84,000.
	C.	$14,172.
	D.	$1,753.

3)

A company projects an increase in net income of $180,000 each year for the next five years if it invests $900,000 in new equipment. The equipment has a five-year life and an estimated salvage value of $300,000. What is the annual rate of return on this investment?

	A.	20%
	B.	30%
	C.	25%
	D.	50%

4)

If an asset cost $70,000 and is expected to have a $10,000 salvage value at the end of its ten-year life, and generates annual net cash inflows of $10,000 each year, the cash payback period is

	A.	8 years.
	B.	7 years.
	C.	6 years.
	D.	5 years

Answer 1

1)

Internal rate of return is the rate at which Net present value of the project is zero.

Cost of project = $75,930

The project is expected to generate cash inflows of $30,000 each year for three years.

Annual cash flows are to be discounted at a rate at which net present value of the project becomes zero.

Minimum required rate of return = 8%.

Present value of cash inflows (at 8%) = Annual cash inflows x PVAF(8_{% , 3} )

= 30,000 x 2.5771

= $77,313

NPV (at 8%) = Present value of cash inflows - Present value of cash outflows

= 77,313 - 75,930

= $1,383

Since at 8% discount rate, NPV of the project is positive, we must take a higher discount rate so that NPV becomes zero

Let second discount rate be 9%.

Present value of cash inflows (at 9%) = Annual cash inflows x PVAF(9_{% , 3} )

= 30,000 x 2.5312

= $75,936

NPV (at 9%) = Present value of cash inflows - Present value of cash outflows

= 75,936 - 75,935

= $1

Hence, at 9%, net present value is almost zero. Thus Internal rate of return is close to 9%

Correct option is (B)

2)

Present value of cash inflows (at 9%) = Annual cash inflows x PVAF(9_{% , 3} )

= 56,000 x 2.53129

= $141,753

NPV (at 9%) = Present value of cash inflows - Present value of cash outflows

= 141,753 - 140,000

= $1,753

Correct option is (D)

3)

Average investment = 1/2 (Initial investment + Scrap value)

= 1/2 (900,000 + 300,000)

= 1/2 x 1,200,000

= $600,000

Annual rate of return = Net income/Average investment

= 180,000/600,000

= 30%

Correct option is (B)

4)

Cash payback period = Initial investment/Annual cash inflow

= 70,000/10,000

= 7 years

Correct option is (B)