3.1. What is the payback period for the following set of cash flows?

Year 0 1 2 3 4
Cash Flow -6,400 1,600 1,900 2,300 1,400
3.2. An investment project provides cash inflows of $765 per year for eight years. What is the
project payback period if the initial cost is $2,400? What if the initial cost is $3,600? What if it is
$6,500?

3.3. Buy Coastal, Inc. imposes a payback cutoff of three years for its international investment
projects. If the company has the following two projects available, should it accept either of them?

Year Cash Flow (A) Cash Flow (B)

0 -40,000 -60,000
1 19,000 14,000
2 25,000 17,000
3 18,000 24,000
4 6,000 270,000
3.4. An investment project has annual cash inflows of $4,200, $5,300, $6,100, and $7,400, and a
discount rate of 14 percent. What is the discounted payback period for these cash flows if the
initial cost is $7,000? What if the initial cost is $10,000? What if it is $13,000?

3.5. An investment project costs $15,000 and has annual cash flows of $4,300 for six years. What
is the discounted payback period if the discount rate is zero percent? What if the discount rate is 5
percent? If it is 19 percent?

3.6. A firm evaluates all of its projects by applying the IRR rule. If the required return is 16
percent, should the firm accept the following project?

Year 0 1 2 3
Cash Flow -34,000 16,000 18,000 15,000
3.7. For the cash flows in the previous problem, suppose the firm uses the NPV decision rule. At
a required return of 11 percent, should the firm accept this project? What if the required return
was 30 percent?

3.8. A project that provides annual cash flows of $28,500 for nine years costs $138,000 today. Is
this a good project if the required return is 8 percent? What if it’s 20 percent? At what discount
rate would you be indifferent between accepting the project and rejecting it?

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3.9. What is the IRR of the following set of cash flows?

Year 0 1 2 3
Cash Flow -19,500 9,800 10,300 8,600
3.10. For the cash flows in the previous problem, what is the NPV at a discount rate of zero
percent? What if the discount rate is 10 percent? If it is 20 percent? If it is 30 percent?

3.11. Mahjong, Inc., has identified the following two mutually exclusive projects:

Year Cash Flow A Cash Flow B

0 -43,000 -43,000
1 23,000 7,000
2 17,900 13,800
3 12,400 24,000
4 9,400 26,000
a. What is the IRR for each of these projects? Using the IRR decision rule, which project should
the company accept?

b. If the required return is 11 percent, what is the NPV for each of these projects? Which project
will the company choose if it applies the NPV decision rule?

3.12. A proposed new investment has projected sales of $830,000. Variable costs are 60 percent
of sales, and fixed costs are $181,000; depreciation is $77,000. Prepare a pro forma income
statement assuming a tax rate of 35 percent. What is the projected net income?

3.13. Consider the following income statement:

Sales $824,500
Costs 538,900
Depreciation 126,500
EBIT ?
Taxes (34%) ?
Net income ?
Fill in the missing numbers and then calculate the OCF. What is the depreciation tax shield?

3.14. Summer Tyme, Inc., is considering a new three-year expansion project that requires an
initial fixed asset investment of $3.9 million. The fixed asset will be depreciated straight-line to
zero over its three-year tax life, after which time it will be worthless. The project is estimated to
generate $2,650,000 in annual sales, with costs of $840,000.
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a. If the tax rate is 35 percent, what is the OCF for this project?

b. In the previous problem, suppose the required return on the project is 12 percent. What is the
project’s NPV?

3.15. A project has annual cash flows of $7,500 for the next 10 years and then $10,000 each year
for the following 10 years. The IRR of this 20-year project is 10.98%. If the firm’s WACC is 9%,
what is the project’s NPV?

3.16. Your division is considering two projects. Its WACC is 10% and the projects’ after-tax cash
flows (in millions of dollars) would be as follows:

Year 0 1 2 3 4
Project A -30 5 10 15 20
Project B -30 20 10 8 6
a. Calculate the projects’ NPVs, IRRs, regular paybacks and discounted paybacks.

b. If the two projects are independent, which project(s) should be chosen?

c. If the two projects are mutually exclusive and the WACC is 10%, which project(s) should be
chosen?

d. Plot NPV profiles for the two projects. Identify the projects’ IRRs on the graph.

e. If the WACC was 5%, would this change your recommendation if the projects were mutually
exclusive? If the WACC was 15%, would this change your recommendation? Explain your
answers.

f. The crossover rate is 13.5252%. Explain what this rate is and how it affects the choice between
mutually exclusive projects?

g. Is it possible for conflicts to exist between the NPV and the IRR when independent projects are
being evaluated? Explain your answer.

h. Now look at the regular and discounted paybacks. Which project looks better when judged by
the paybacks?