16 May WHAT IS THE PAYBACK PERIOD FOR THE PROPOSED INVESTMENT IN THE 3D PRINTER?
FNCE 370v9: Assignment 3
Assignment 3 is worth 5% of your final mark. Complete and submit Assignment 3 after you complete Lesson 9.
Question Marks available Marks awarded Reference
1 12 Lesson 7
2 3 Lesson 7
3 13 Lesson 7
4 10 Lesson 8
5 13 Lesson 8
6 9 Lesson 8
7 9 Lesson 9
8 17 Lesson 9
9 14 Lesson 9
Total 100
Note on Decimal Places
When working through numerical problems, use as many decimal places as shown on your financial calculator. Do not round your calculated answers until you have reached the final answer. When you reach your final answer, round as follows, unless the question specifies otherwise.
Percentages: round to two decimal places
Dollars: round to two decimal places
Others: round to four decimal places
Questions
1. Choo Choo Inc. is a manufacturer of model trains. The company is considering the purchase of an industrial 3D printer, which will allow the firm to produce custom-made model trains for its high-end customers. The printer will cost $1,000,000, and it is expected to produce net cash flows of $350,000 per year for the next six years. Liquidation of the equipment will net the firm $100,000 in cash at the end of six years. The firm requires a 13% rate of return on all investments. Ignore the effects of taxes. (12 marks total)
a. What is the payback period for the proposed investment in the 3D printer? Provide your answer in number of years and months. (1 mark)
b. What is the printer’s discounted payback period? Provide your answer in number of years and months. (2 marks)
c. Choo Choo’s cutoff period is set at three years. Based on the payback period investment criterion, will the company purchase the printer? Will it purchase the printer based on the discounted payback period investment criterion? (1 mark)
d. What is the printer’s net present value (NPV)? Should the company purchase the printer based on the NPV investment criterion? (2.5 marks)
e. What is the printer’s profitability index (PI)? Should the company purchase the printer based on the PI investment criterion? (1.5 marks)
f. What is the printer’s internal rate of return (IRR)? (2 marks)
g. Check that at the internal rate of return (IRR) the net present value of the printer is $0. Should the company purchase the printer based on the IRR investment criterion? (1.5 marks)
h. Based on your answers in parts a-f above, what decision do you recommend for Choo Choo? (0.5 mark)
2. Given the following information and ignoring taxes, what is the annual cash revenue that will make the net present value equal to zero (i.e., the annual cash revenue that will cause us to break-even in the financial sense)? (3 marks)
Annual cash costs = $14,000
Life of project = 8 years
Initial cost of project = $30,000
Salvage value at end of project = $2,000
Required rate of return = 15%
3. We have two mutually exclusive investments with the following cash flows: (13 marks total)
Year Investment A Investment B
0 -$100 -$100
1 50 20
2 40 40
3 40 50
4 30 60
a. Using a financial calculator, calculate the IRR for each of the investments. (1 mark)
b. Based on the IRR rule and a required return of 15%, which investment should we choose? (1 mark)
c. Calculate the NPV profile for each investment, using the discount rates of 0%, 5%, 10%, 15%, 20%, and 25%. Perform this task in an Excel spreadsheet. Cautionary note: If you use the =NPV() function in Excel to calculate the NPVs, it will provide incorrect answers. The NPV() function actually calculates the present value of all cash inflows. The NPV should be calculated as =NPV(all cash inflows) – initial cash outflow. (2 marks)
d. Plot the NPV profile for both projects using the X-Y scatter function in Excel. (2 marks)
e. If the required return on this project is 16%, would both NPV and IRR give us the same conclusion? Explain your answer. (2.5 marks)
f. If the required return on this project is 9%, would both NPV and IRR give us the same conclusion? Explain your answer. (2.5 marks)
h. Calculate the crossover rate at which we are indifferent between the two investments. (2 marks)
4. A proposed cost-saving project requires a device with an installed cost of $540,000. The project will last for five years. The device has a CCA rate of 20%. The required initial net working capital investment is $20,000, the marginal tax rate is 37%, and the required return on the project is 11%. The device has an estimated salvage value of $95,000 at the end of Year 5, and the net working capital investment will also be recovered at the end of Year 5. What level of pre-tax cost savings do we require for this project to be profitable? (10 marks
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