Question

Question # 1

Toronto Company is considering two new machines that should produce considerable cost savings in its assembly operations. The cost of each machine is $20,000 and neither is expected to have a salvage value at the end of a 4-year useful life. The required rate of return of the company is 10% and the company prefers that a project return its initial outlay within the first half of the project’s life. The annual after-tax cash savings for each machine are provided in the following table:

Year	Annual After-tax Cash Savings
	Project A	Project B
1	$2,000	$10,000
2	4,000	8,000
3	8,000	4,000
4	10,000	2,000
Salvage value-Year 4	6,000	6,000
Total	30,000	30,000

Present value factors @ 10%

Year	1	2	3	4	5
PV factor	0.909	0.826	0.751	0.683	0.621

Required:

1. Which project is more desirable strictly in terms of cash inflows? (1)

2. Which of the following is the correct Present value of cash inflows for Project A, assuming the company's required rate of return is 10%? (2)

A) $17,960                

B) $22,058

C) $7000

D) None of the above

3. Which of the following is the correct Present value of cash inflows for Project B, assuming the company's required rate of return is 10%? (2)

A) $7225                

B) $24,166

C) $7000

D) None of the above

4. Which of the following is the correct Net Present value of Project A, assuming the company's required rate of return is 10%? (1)

A) -$2040               

B) $52

C) 2,058

D) None

5. Which of the following is the correct Net Present value of Project B, assuming the company's required rate of return is 10%? (1)

A) -4100               

B) $68

C) 4,166

D) None

6. What is the maximum amount the company should be willing to pay for project A? (1)

A) -$100

B) $17,960

C) -$225

D) None of the above

7. What is the present value index for Project A? (1)

A) 1.10

B) .898

C) 1.25

D) 1.12

7. What is the present value index for Project A? (1)

A) 1.10

B) .898

C) 1.25

D) 1.12

8. What is the present value index for Project B? (1)

A) 1.0034

B) 1.21

C) 1.40

D) 1.25

9. Which project is better on the basis of present value index? (1)

A) Project A

B) Project B

C) Both are same

D) Cannot be determined

10. Which project(s) should be accepted based on NPV? (1)

A) Project A

B) Project B

C) Both are same

D) Cannot be determined

11. What is the payback period for Project A?(1)

A) 4 years

B) 3.3 years

C) 2.67 years

D) 3 years

12. What is the payback period for Project B?(1)

A) 4 years

B) 3.3 years

C) 2.67 years

D) Cannot be determined

13. Which project is better on the basis of payback period? (1)

A) Project A

B) Project B

C) Both are same

D) Cannot be determined

Answer 1

1.Both are same since equal cash flows

2.PV of cash inflows = 2000*0.909+4000*0.826+8000*0.751 + 10,000*0.683 + 6000*0.683

= $22,058

3.Project B = 10,000*0.909+8,000*0.826+4,000*0.751 + 2,000*0.683 + 6000*0.683

= $24,166

4.NPV of A = 22,058 – 20,000

= $2,058

C

5.B = 24166-20,00

= $4,166

C

6.Maximum amount = PV of Cash Inflows – NPV of B

= 22058-4166

= $17,892

7.PV index = PV of cash inflows/PV of cash Outflows

= 22058/20,000

= 1.1029

i.e. 1.10

8.B = 24166/20,000

= 1.2083

i.e. 1.21

9. Project B is better

10.Project B

11.Payback is the time period in which initial investment is recovered

Project A = 3+(20,000-2,000-4,000-8,000)/16,000

= 3.375 years i.e. 3.3 years

12. B = 2+ (2000/4000)

= 2.5 years

i.e. 2.67 approx.

13. Project B