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# Penn State - Corporate Finance - Study Guide

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Penn State - Corporate Finance - Study Guide

##### Description: The Payback Period Rule 6
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The Payback Period Rule 6.1 Fuji Software, Inc., has the following mutually exclusive projects. a. Suppose Fuji’s payback period cutoff is two years.  Which of these two projects should
be chosen?
b. Suppose Fuji uses the NPV rule to rank these two projects.  Which project should be
chosen if the appropriate discount rate is 15 percent?
6.2 Suppose Peach Paving, Inc. invests \$1 million today on a new construction project.  The project
will generate annual cash flows of \$150,000 in perpetuity.  The appropriate annual discount rate
for the project is 10 percent.
a. What is the payback period for the project?  If Peach Paving, Inc.’s cutoff is 10-years,
should the project be accepted?
b. What is the discounted payback period for the project? c. What is the NPV of the project? The Average Accounting Return 6.3 Your firm is considering purchasing a machine with the following annual, end-of-year, book-
investment accounts.
Purchase Date Year 1 Year 2 Year 3 Year 4 Gross Investment \$16,000 \$16,000 \$16,000 \$16,000 \$16,000 Less: Accumulated
Depreciation
0 4,000 8,000 12,000 16,000 Net Investment \$16,000 \$12,000 \$8,000 \$4,000 \$0 The machine generates, on average, \$4,500 per year in additional net income.   a. What is the average accounting return for this machine? b. What three flaws are inherent in this decision rule? 6.4 Western Printing Co. has an opportunity to purchase a \$2 million printing machine.  The machine
has an economic life of five years and will be worthless after that time.  It will generate net income
of \$100,000 one year from today and the income stream will grow at seven percent per year
thereafter.  The company uses straight-line depreciation (i.e., equal depreciation each year).  What
is the average accounting return of the investment?  Should the machine be purchased if Western
Printing’s average accounting return cutoff is 20 percent?
6.5 The Bluerock Group has invested \$8,000 in a high-tech project lasting three years.  Depreciation is
\$4,000, \$2,500, and \$1,500 in years 1, 2, and 3, respectively.  The project generates pre-tax
income \$2,000 each year.  The pre-tax income already includes the depreciation expense.  If the
tax rate is 25%, what is the project’s average accounting return (AAR)?
Copyright 2003, McGraw-Hill.  All rights reserved. Year Project A Project B 0 -\$7,500 -\$5,000 1 4,000 2,500 2 3,500 1,200 3 1,500 3,000
The Internal Rate of Return 6.6 Compute the internal rate of return on projects with the following cash flows. Cash Flows (\$) Year Project A Project B 0 -3,000 -6,000 1 2,500 5,000 2 1,000 2,000 6.7 Teddy Bear Planet, Inc. has a project with the following cash flows.    Year Cash Flows (\$) 0 -8,000 1 4,000 2 3,000 3 2,000 a. Compute the internal rate of return on the project.   b. Suppose the appropriate discount rate is eight percent.  Should the project be accepted? 6.8 Compute the internal rate of return for the cash flows of the following two projects.   Cash Flows (\$) Year Project A Project B 0 -2,000 -1,500 1 2,000 500 2 8,000 1,000 3 8,000 1,500 6.9 Suppose you are offered \$5,000 today but must make the following payments.   Year Cash Flows (\$) 0 5,000 1 -2,500 2 -2,000 3 -1,000 4 -1,000 a. What is the IRR of this offer?   b. If the appropriate discount rate is 10 percent, should you accept this offer? c. If the appropriate discount rate is 20 percent, should you accept this offer? d. What is the NPV of the offer if the appropriate discount rate is 10 percent?  20 percent? e. Are the decisions under the NPV rule in part (d) consistent with those of the IRR rule?   Copyright 2003, McGraw-Hill.  All rights reserved.

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Join more than 18,000+ college students at Pennsylvania State University who use StudySoup to get ahead
##### Description: The Payback Period Rule 6
5 Pages 123 Views 98 Unlocks
• Notes, Study Guides, Flashcards + More!
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