1. You have the following information to evaluate a project and make a decision whether you should accept the project:
Purchase price = $120,000 (20 year life, straight-line depreciation, zero salvage value).
Operating expenses will decrease from $30,000 to $20,000.
Revenue will increase from $50,000 to $57,000.
Marginal tax rate = 40%
Risk-free rate = 2.5%
Return on the market = 5.5%
Beta = 1.5
Should you accept this project? Why?
2. Evaluate the following project.
Year CF ALPHA
0 -20,000 1.00
1 6,000 .95
2 5,000 .90
3 8,000 .80
4 10,000 .75
a) If the project has a beta equal to 1.3, the return on the market is 8%, and the risk-free rate is 6%. Use the risk-adjusted discount approach to evaluate this project. Should you accept this project?
b) Using the certainty equivalent approach, should you accept the project?
3. You are considering two mutually exclusive projects that offer the following net cash flows.
Year A B
0 -30,000 -30,000
1 10,500 6,500
2 10,500 6,500
3 10,500 6,500
4 10,500 6,500
5 6,500
6 6,500
7 6,500
8 6,500
a) Compute the NPV of each project at a 12% cost of capital.
b) Create a replacement chain assuming that the reinvestment and estimated cash flows remain the same.
c) Which project should you accept?
d) Use the equivalent annual annuity approach to solve the problem. How does it compare to the answer in part C?