ACF 103 – Fundamentals of Finance

Tutorial 8 - Questions
Chapter 13
1. Your firm is considering two mutually exclusive projects, code-named A and
B, that would each require an initial cash outflow of $10,000. They would
generate the following incremental, after-tax, operating cash flows:

Project A Project B
Year 1 $5,000 $3,000
Year 2 4,000 4,000
Year 3 3,000 6,000

If the firm's required rate of return is 14%, which would you select?
A. Project A because it has the shorter payback period.
B. Project A because it has the higher net present value.
C. Project B because it has the higher internal rate of return.
D. Neither project because neither adds value to the firm.

2. A strip mine will have an initial cash outflow of $25 million and expected
after-tax, operating cash inflows of $5 million per year over its 10-year
economic life. However, the Environmental Protection Agency requires repair
and replanting of mined areas every five years. This will result in additional
after-tax outflows of $6 million in years five and ten. Based on this scenario,
which of the following statements is true?
A. The project's payback period is five years.
B. The value of this project today can be calculated as the sum of the cash
inflows minus the cash outflows.
C. A profitability index cannot be calculated for this project because there
are negative cash flows in some years.
D. This project may have more than one internal rate of return.

Homework problem
3. A firm is considering two mutually exclusive investment alternatives, both of
which cost $5,000. The firm's hurdle rate is 12%. The after-tax cash flows
associated with each investment are:

Year Investment A Investment B

1 $2,000 $1,000
2 1,500 1,500
3 1,500 2,000
4 1,000 3,000

For each alternative, calculate the payback period, the net present value, and
the profitability index. Which alternative (if any) should be selected?

4. The Cardinal Machine Tool Company is considering the purchase of a new

drill press to replace the one currently being used. The present machine is
expected to last another seven years and have no salvage value. The drill press
in current use has a book value of $700 and can be sold today for $400.
Cardinal pays $300 a year maintenance on the press. The new drill press will

ACF 103 HAUT 2015 Tutorial 8 1

 cost $1,500. It is expected to last seven years, at which time it will be sold for
$100. The maintenance cost of the new machine is expected to be $150 a year.
Cardinal depreciates its assets on the straight-line basis and pays 40% taxes. If
its opportunity cost of funds is 10%, should it buy the new machine?

5. A firm is considering the following projects, all of which are independent of

one another. Available funds are limited to $2 million in this capital budgeting
period, but future periods will have no capital budget constraints.
Present Value of
Project Initial Outlay Cash Inflows
1 $1,300,000 $1,200,000
2 1,000,000 1,250,000
3 800,000 900,000
4 600,000 700,000
5 500,000 550,000
6 400,000 470,000
7 300,000 280,000
8 100,000 105,000

Which projects should be accepted without exceeding the budget?

6. Text book Ch 13, problem # 8 (p.348)

ACF 103 HAUT 2015 Tutorial 8 2