Chapter #7

Solutions to Questions and Problems

1. P0 = $43.75
P3 = $50.65
P15 = $90.95

2. R = .1033 or 10.33%

3. Dividend yield = .0383 or 3.83%
Capital gains yield = 6.5%

4. P0 = $56.25

5. R = .1010 or 10.10%

7. P0 = $77.19

8. R = .0776 or 7.76%

10. g = .0593 or 5.93%

11. P19 = $222.22
P0 = $43.22

12. Using the constant growth model and a required return of 15 percent, the stock price today
is:
P0 = $37.50

And the stock price today with a 10 percent return will be:
P0 = $75.00

All else held constant, a higher required return means that the stock will sell for a lower
price.

13. P6 = $87.50
P0 = $42.03

14. P0 = $72.27

15. P4 = $52.50
P0 = $69.27

16. P3 = $66.40
P0 = $54.47
17. P0 = $49.24
18. D0 = $5.55

21. Dividend yield = D/PLow

Dividend yield = .0205 or 2.05%

Dividend yield = D/PHigh

Dividend yield = .0140 or 1.40%

Chapter #8
Solutions to Questions and Problems

1. Payback = 2.75 years

2. If the initial cost is $3,400, the payback period is:
Payback = 4.10 years

For the $3,400 cost, the payback period is:
Payback = 4.10 years

For an initial cost of $4,450, the payback period is:
Payback = 5.36 years

The payback period for an initial cost of $6,800 is 
Total cash inflows = $6,640
If the initial cost is $6,800, the project never pays back. Notice that if you use the shortcut
for annuity cash flows, you get:

Payback = $6,800 / $830 
Payback = 8.19 years.

This answer does not make sense since the cash flows stop after eight years, so again, we
must conclude the payback period is never

3. Project A:
Payback = 2.44 years

Project B:
Payback = 3.06 years

4. Average net income = $1,498,000
Average book value = $7,000,000
AAR = .2140 or 21.40%
5. IRR = 19.03% 

6. The NPV of this project at an 11 percent required return is:
NPV = $14,186.14 

The NPV of the project at a 23 percent required return is:
NPV = – $5,936.05  

7. The NPV of this project at an 8 percent required return is:
NPV = $2,296.27 

The NPV of the project at a 24 percent required return is:
NPV = –$921.40 

IRR = .1779 or 17.79% 
8. IRR = 25.02%

9. The NPV of the project at a zero percent required return is:
NPV = $15,000

The NPV at a 10 percent required return is:
NPV = $7,683.70

The NPV at a 20 percent required return is:
NPV = $2,231.48

And the NPV at a 30 percent required return is:
NPV = – $1,948.57

10. a. The IRR of Project A is:
IRR = 18.72%

The IRR of Project B is:
IRR = 18.13%

b. The NPV of Project A is:
NPVA = $4,108.69

And the NPV of Project B is:
NPVB = $5,623.44

c. To find the crossover rate, we subtract the cash flows from one project from the cash
flows of the other project. Here, we will subtract the cash flows for Project B from the
cash flows of Project A. Once we find these differential cash flows, we find the IRR. 

R = 16.82%

At discount rates above 16.82% choose project A; for discount rates below 16.82%
choose project B; indifferent between A and B at a discount rate of 16.82%.
11. The IRR of Project X is:
IRR = 16.82%

For Project Y
IRR = 16.60%

To find the crossover rate, we subtract the cash flows from one project from the cash flows
of the other project, and find the IRR of the differential cash flows. We will subtract the cash
flows from Project Y from the cash flows from Project X. It is irrelevant which cash flows
we subtract from the other. Subtracting the cash flows, the equation to calculate the IRR for
these differential cash flows is:

R = 13.28%

The table below shows the NPV of each project for different required returns. Notice that
Project Y always has a higher NPV for discount rates below 13.28 percent, and always has a
lower NPV for discount rates above 13.28 percent.

R $NPVX   $NPVY
0%       1,700.00          1,800.00 
5%       1,100.21          1,155.49 
10%          587.53             607.06 
15%          145.56             136.35 
20%        (238.43)          (270.83)
25%        (574.40)          (625.60)

12. a. NPV = $13,570,247.93 

b. 0 = –$28M + $53M/(1+IRR) – $8M/(1+IRR)2 

From Descartes rule of signs, we know there are two IRRs since the cash flows change
signs twice. From trial and error, the two IRRs are:

   IRR = 72.75%, –83.46%

When there are multiple IRRs, the IRR decision rule is ambiguous. Both IRRs are
correct, that is, both interest rates make the NPV of the project equal to zero. If we are
evaluating whether or not to accept this project, we would not want to use the IRR to
make our decision.
13. The profitability index at a required return of 10 percent is:
PI = 1.101

The profitability index at a required return of 15 percent is:
PI = 1.021

The profitability index at a required return of 22 percent is:
PI = 0.926

14. a. PII = 1.077  
PIII = 1.161  

b. NPVI = $2,689.41
NPVII = $887.60

c. Using the profitability index to compare mutually exclusive projects can be ambiguous
when the magnitude of the cash flows for the two projects are of different scale. In this
problem, project I is roughly 3 times as large as project II and produces a larger NPV,
yet the profitability index criterion implies that project II is more acceptable.

15. a. The payback period for each project is:

A: 3.31 years
B: 1.76 years

b. The NPV for each project is:

A: NPV =  $107,716.12
B: NPV =  $11,148.02

c. The IRR for each project is:

A: IRR = 26.90%

B: IRR = 38.27%

d. The profitability index for each project is:

A: PI = 1.427

B: PI = 1.465
e. In   this   instance,   the   NPV   criterion   implies   that   you   should   accept   project   A,   while
payback period, IRR, and the profitability index imply that you should accept project B.
The   final   decision   should   be   based   on   the   NPV   since   it   does   not   have   the   ranking
problem associated with the other capital budgeting techniques. Therefore, you should
accept project A.
16. a. The IRR for each project is:

M: IRR = 23.85%

N: IRR = 21.65%

b. The NPV for each project is:

M: NPV = $32,271.63

N: NPV = $37,458.54

c. Accept project N since the NPV is higher. IRR cannot be used to rank mutually
exclusive projects.

17. a. The profitability index for each project is:

Y: PI = 1.123

Z: PI = 1.108

b. The NPV for each project is:

Y: NPV = $5,544.98

Z: NPV = $6,987.50

c. Accept project N since the NPV is higher. The profitability index cannot be used to
rank mutually exclusive projects.
18. To find the crossover rate, we subtract the cash flows from one project from the cash flows
of the other project, and find the IRR of the differential cash flows. We will subtract the cash
flows from Project J from the cash flows from Project I. It is irrelevant which cash flows we
subtract from the other. Subtracting the cash flows, the equation to calculate the IRR for
these differential cash flows is:

Crossover rate: 0 = $7,000/(1+R) + $2,000/(1+R)2 – $3,000/(1+R)3 – $8,000/(1+R)4  

R = 8.34%

At a lower interest rate, project J is more valuable because of the higher total cash flows. At
a higher interest rate, project I becomes more valuable since the differential cash flows
received in the first two years are larger than the cash flows for project J.

21. a. The payback period for each project is:

F: 2.13 years

G: 3.14 years

b. The NPV for each project is:

F: NPV = $100,689.53

G: NPV = $110,147.47

c. Even though project H does not meet the payback period of three years, it does provide
the largest increase in shareholder wealth, therefore, choose project H. Payback period
should generally be ignored in this situation.

22. To find the crossover rate, we subtract the cash flows from one project from the cash flows
of the other project, and find the IRR of the differential cash flows. We will subtract the cash
flows from Project S from the cash flows from Project R. It is irrelevant which cash flows
we subtract from the other. Subtracting the cash flows, the equation to calculate the IRR for
these differential cash flows is:

0 = $18,000 – $4,000/(1+R) – $9,000/(1+R) 2 – $3,000/(1+R)3 – $4,000/(1+R)4 – $4,000/(1 +
R)5 

R = 11.26%
The NPV of the projects at the crossover rate must be equal, The NPV of each project at the
crossover rate is:

F: NPV = $10,896.47

G: NPV = $10,896.47
23. The IRR of the project is:

R = 13.16%

At an interest rate of 12 percent, the NPV is:

NPV = –$1,051.02

At an interest rate of zero percent, we can add cash flows, so the NPV is:
NPV = –$14,000.00

And at an interest rate of 24 percent, the NPV is:

NPV = +$8,588.97

The cash flows for the project are unconventional. Since the initial cash flow is positive and
the remaining cash flows are negative, the decision rule for IRR in invalid in this case. The
NPV profile is upward sloping, indicating that the project is more valuable when the interest
rate increases.

Chapter #9
Solutions to Questions and Problems

1. Cash flow = $23,850,000

2. Sales due solely to the new product line are: $224,000,000 

Increased sales of the motor home line occur because of the new product line introduction =
$125,000,000 

Erosion of luxury motor coach sales is also due to the new mid­size campers = $81,000,000
loss in sales 

The net sales figure to use in evaluating the new line is thus:
Net sales = $224,000,000 + 125,000,000 – 81,000,000 
Net sales = $268,000,000

3. We need to construct a basic income statement. The income statement is:

Sales $ 950,000
Variable costs 570,000
Fixed costs 210,000
Depreciation 102,000
EBIT $ 68,000
Taxes@35% 23,800
Net income $ 44,200

4. OCF = $261,866
Depreciation tax shield = $38,500
5. The depreciation schedule for this asset is:  

Beginning Beginning Depreciation Depreciation Ending

Year Book Value       %           Allowance Book Value
1 $975,000.00 14.29% $139,327.50 $835,672.50
2 835,672.50 24.49% 238,777.50 596,895.00
3 596,895.00 17.49% 170,527.50 426,367.50
4 426,367.50 12.49% 121,777.50 304,590.00
5 304,590.00 8.93% 87,067.50 217,522.50
6 217,522.50 8.93% 87,067.50 130,455.00
7 130,455.00 8.93% 87,067.50 43,387.50
8 43,387.50 4.45% 43,387.50 0
6. Annual depreciation = $72,500
Accumulated depreciation = $362,500
BV5 = $217,500
Aftertax salvage value = $144,375

7. BV4 = $1,226,880
Aftertax salvage value = $1,407,139.20

8. OCF = $11,652,500

9. OCF = $1,170,500

10. NPV = $317,470.29

11. NPV = $367,832.61

13. Annual depreciation = $98,000
Aftertax salvage value = $26,400
OCF = $129,680
NPV = $34,562.45

14. Annual depreciation charge = $170,000
Aftertax salvage value = $117,000
OCF = $261,000
IRR = 21.28%

15. OCF = $280,500
NPV = $80,745.56

The NPV with a $280,000 cost savings is:
OCF = $241,500
NPV = – $35,888.31

20. OCF = $159,400

Payback period = 3.26 years
NPV = –$45,869.27
IRR = 8.69%

21. NPV = $31,683.79
Problem #23, (part a only)
23. a. OCFbase = $489,375
NPVbase = $447,155.04

OCFworst = $277,280
NPVworst = –$158,371.60

OCFbest = $734,230
NPVbest = $1,146,210.76

24. Initial cost = $19,500,000

OCF = $5,311,429
Payback period = 3.67 years
NPV = $3,716,625.90
IRR = 19.91%