Long-term investment decision, payback method Bill Williams has the opportunity to invest in project

P10-4 P10-10 P10-11 P10-15 P10-21 P10-24  P10–4 

Long-term investment decision, payback method Bill Williams has the opportunity to invest in project A that costs $9,000 today and promises to pay annual end-ofyear

payments of $2,200, $2,500, $2,500, $2,000, and $1,800 over the next 5 years. Or, Bill can invest $9,000 in project B that promises to pay annual end-of-year payments

of $1,500, $1,500, $1,500, $3,500, and $4,000 over the next 5 years.

a. How long will it take for Bill to recoup his initial investment in project A?

b. How long will it take for Bill to recoup his initial investment in project B?

c. Using the payback period, which project should Bill choose?

d. Do you see any problems with his choice?

P10–10 Hook Industries is considering the replacement of one of its old drill presses. Three alternative replacement presses are under consideration.

The relevant cash flows associated with each are shown in the following table. The firm’s cost of capital is 15%.

P10–11 Long-term investment decision, NPV method Jenny Jenks has researched the financial pros and cons of entering into an elite MBA program at her state university.

The tuition and needed books for a master’s program will have an upfront cost of $100,000. On average, a person with an MBA degree earns an extra $20,000 per

year over a business career of 40 years. Jenny feels that her opportunity cost of capital is 6%. Given her estimates, find the net present value (NPV) of entering this

MBA program. Are the benefits of further education worth the associated costs?

P10–15 Internal rate of return. Peace of Mind, Inc. (PMI), sells extended warranties for durable consumer goods such as washing machines and refrigerators. When PMI sells an extended warranty, it receives cash up front from the customer, but later PMI must cover any repair costs that arise. An analyst working for PMI is considering a warranty for a new line of big-screen TVs. A consumer who purchases the 2-year warranty will pay PMI $200. On average, the repair costs that PMI must cover will average $106 for each of the warranty’s 2 years. If PMI has a cost of capital of 7%, should it offer this warranty for sale?

P10-21 All techniques, conflicting rankings Nicholson Roofing Materials, Inc., is considering

two mutually exclusive projects, each with an initial investment of $150,000.

The company’s board of directors has set a maximum 4-year payback requirement

and has set its cost of capital at 9%. The cash inflows associated with the two

projects are shown in the following table.

P10–24 All techniques: Decision among mutually exclusive investments Pound Industries is
attempting to select the best of three mutually exclusive projects. The initial investment
and after-tax cash inflows associated with these projects are shown in the
following table.

Cash flows Project A Project B Project C

Initial investment (CF0) $60,000 $100,000 $110,000

Cash inflows (CFt), t 5 1 to 5 20,000 31,500 32,500

a. Calculate the payback period for each project.

b. Calculate the net present value (NPV) of each project, assuming that the firm has

a cost of capital equal to 13%.

c. Calculate the internal rate of return (IRR) for each project.

d. Draw the net present value profiles for both projects on the same set of axes, and

discuss any conflict in ranking that may exist between NPV and IRR.

e. Summarize the preferences dictated by each measure, and indicate which project

you would recommend. Explain why.