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Cost of Capita and Cash Flow Questionnaire

Cost of Capita and Cash Flow Questionnaire

Description

1. You own a coal mining company and are considering opening a new mine. The mine itself will cost $116 million to open. If this money is spent immediately, the mine will generate $19 million for the next 10 years. After that, the coal will run out and the site must be cleaned and maintained at environmental standards. The cleaning and maintenance are expected to cost $1.5 million per year in perpetuity.

What does the IRR rule say about whether you should accept this opportunity? (Hint: Consider the number of sign changes in the cash flows.)

A.

The IRR is 8.72%,so accept the opportunity.

B.

There are two IRRs, so you cannot use the IRR as a criterion for accepting the opportunity.

C.

Reject the opportunity because the IRR is lower than the 8.1%cost of capital.

D.

Accept the opportunity because the IRR is greater than the cost of capital.

If the cost of capital is 8.1%,what does the NPV rule say? (Select the best choice below.)

2. If the cost of capital is 8.1% what does the NPV rule say?

A.

The NPV rule cannot be used because there is no IRR.

B.

Since the NPV is greater than or equal to zero, accept the opportunity.

C.

Since the NPV is less than zero, reject the opportunity.

D.

The NPV rule cannot be used because there are two IRRs.

3. FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $219,000 per year. Once in production, the bike is expected to make $328,500 per year for 10 years. Assume the cost of capital is 10%. Note: Assume that all cash flows occur at the end of the appropriate year and that the inflows do not start until year 7.

a. Calculate the NPV of this investment opportunity, assuming all cash flows occur at the end of each year. Should the company make the investment?

The present value of the costs is $

(Round to the nearest dollar.)

The present value of the benefits is $

(Round to the nearest dollar.)

The net present value is $

You should (REJECT OR ACCEPT?) investment because the NPV is (POSITIVE OR NEGATIVE?)

b. By how much must the cost of capital estimate deviate to change the decision? (Hint: Use Excel to calculate the IRR.)

To change the decision, the deviation would need to be %.

c. What is the NPV of the investment if the cost of capital is 15%?

The present value of the costs is $

(Round to the nearest dollar.)

The present value of the benefits is $

(Round to the nearest dollar.)

The NPV will be $

(Round to the nearest dollar.)

4.

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