Rohan Transport is considering two alternative busses to transport people between cities that are in the Southeastern U.S., such as Baton Rouge and Gainesville. A gas-powered bus has a cost of $55,000, and will produce end-of-year net cash flows of $22,000 per year for 4 years. A new electric bus will cost $90,000, and will produce cash flows of $28000 per year for 8 years. The company must provide bus service for 8 years, after which it plans to give up its franchise and to cease operating the route. Inflation is not expected to affect either costs or revenues during the next 8 years. If Rohan Transports cost of capital is 16%, by what amount will the better project increase the company's value?
Answer(s): D
The NPV of the electric bus is $31,632, which is greater than that of two gas-powered busses bought4 years apart. The NPV for the $90,000 electric bus involves multiplying the $28,000 annual cash flows times the present value factor of 4.344, which equals $121,632. Deducting the $90,000 initial cost results in an NPV of $31,632. The NPV for the two gas-powered busses is $10,208, calculated as follows:
Mesa Company is considering an investment to open a new banana processing division. The project in question would entail an initial investment of $45000, and as a result of the project cash inflows of $20000 can be expected in each of the next 3 years. The hurdle rate is 10%. What is the profitability index for the project?
Answer(s): B
At a 10% hurdle rate1 the present value of the future inflows is:20,000 x 2487 = $49,740Thus, the net present value is $4,740 (49,740 -- 45000). The profitability index calculation is:49,740 =-- 1.105345,000
Flex Corporation is studying a capital acquisition proposal in which newly acquired assets will be depreciated using the straight-line method. Which one of the following statements about the proposal would be incorrect if a switch is made to the Modified Accelerated Cost Recovery System (MACRS)?
MACPS is an accelerated method of depreciation under which depreciation expense will be greater during the early years of an asset's life. Thus, the outflows for income taxes will be less in the early years, but greater in the later years1 and the NPV (present value of net cash inflows -- investment) will be increased. The profitability index (present value of net cash inflows ÷ the investment) must increase if the NPV increases.
Capital Invest, Inc. uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming year:Which project(s) should Capital Invest, Inc. undertake during the upcoming year assuming it has no budget restrictions?
Answer(s): C
A company using the NPV method should undertake all projects with a positive NPV, unless some of those projects are mutually exclusive. Given that Projects 2, 3, and 4 have positive NPVs, they should be undertaken. Project 1 has a negative NPV.
Capital Invest, Inc. uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming year:Which project(s) should Capital Invest, Inc. undertake during the upcoming year if it has only $600,000 of funds available?
Given that only $600,000 is available and that each project costs $200,000 or more, no more than two projects can be undertaken. Because Projects 3 and 4 have the greatest NPVs, profitability indexes, and IRRs, they are the projects in which the company should invest.
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