Question

Which of the following distinguishes scenario analysis from sensitivity analysis?

a. Scenario analysis only applies to new product development projects.

b. Sensitivity analysis only applies to new product development projects

c. Sensitivity analysis involves changing one project variable at a time while scenario analysis involves changing more than one project variable at the same time

d. Sensitivity analysis only applies when projects are mutually exclusive.

3. Which of the following statements is true regarding the internal rate of return (IRR)?

a. If the project NPV > 0, then the IRR must be less than the project’s required return.

b. If you are comparing two mutually exclusive projects, always select the one with the higher IRR.

c. IRR and NPV always show the same preference when comparing two mutually exclusive projects

d. If the project has unconventional cash flows, then there may exist more than one IRR None of the above.

4. The modified internal rate of return is specifically designed to address the problems associated with:

a. mutually exclusive projects

b. crossover points

c. unconventional cash flows

d. negative NPV projects

5. Any changes to a firm's projected future cash flows that are caused by adding a new project are referred to as

a. Eroded cash flows

b. Incremental cash flows

c. Direct impact cash flows

d. Depreciated cash flows

6. You are using a net present value profile to compare Projects A and B, which are mutually exclusive. Which one of the following statements correctly applies to the crossover point between these two?

a. The net present value of Project A equals that of Project B, but generally does not equal zero

b. The internal rate of return for Project A equals that of Project B, but generally does not equal zero

c. The net present value of each project is equal to zero

d. The net present value of each project is equal to the respective project's initial cost

7. You are comparing two mutually exclusive projects. The first provides after-tax cash flows of $50,000 per year for 5 years and costs $100,000 to pursue. The second provides after-tax cash flows of $25,000 per year for 25 years, but those cash flows do not begin until 4 years from now. This project costs $30,000 to pursue. Both projects have a required return of 12%. Select the option below with the correct NPVs and the correct project choice.

a. NPV1=$80,238.81; NPV2=$94,611.42; choose project 2

b. NPV1=$80,238.81; NPV2=$166,078.48; choose project 2

c. NPV1=$71,641.79; NPV2=$65,724.88; choose project 1

d. None of the above are correct.

8. The Canton Sundae Corporation is considering the replacement of an existing machine. The new machine, called an X-tender, would provide better sundaes, but it costs $120,000. The X-tender requires $20,000 in additional net working capital, which will be recouped at the end of the project. The machine’s useful life is 10 years, after which it can be sold for a salvage value of $40,000. Straight-line depreciation will be used and the machine will be depreciated to zero over the 10-year project. The tax rate is 45% and the required return is 16%. The machine is expected to increase “sales minus costs” by $35,000 per year. What are NPV, PI, Payback Period, Discounted Payback Period, and IRR?  

9. Gilmore Golf, Inc is considering producing and selling a new line of golf clubs. The clubs will sell for $690 per set and have a variable cost of $255 per set. The company has spent $250,000 for a marketing study that determined the company will sell 5,000 sets per year for 20 years. The marketing study also determined that the company will lose sales of 2,000 sets per year of its high-priced clubs, which currently sell for $1000 per set and have variable costs of $475. The fixed costs each year will be $150,000. The project will require a net working capital balance equal to 12% of sales of the new clubs, to be fully recouped at the end of the project. This must be put into the project NWC before the project begins. The plant and equipment required will cost $3,500,000 and will be depreciated on a straight-line basis to zero over the lifetime of the project. The company estimates it will be able to sell the plant and equipment in twenty years for 4% of its purchase price. The tax rate is 40% and the required return on the project is 14%. Find the NPV, IRR, and PI. How sensitive is NPV to a change in the price of the new golf clubs?

10. Alexander Industries is considering the purchase of a new machine for the production of latex. Machine A costs $4,900,000 and will last for five years. Variable costs are 35% of sales and fixed costs are $170,000 per year. Machine B costs $8,100,000 and will last for eleven years. Variable costs for this machine are 30% of sales and fixed costs are $130,000 per year. The sales for each machine will be $10 million per year. The required return is 10% and the tax rate is 35%. Both machines will be depreciated straight-line over their lifetimes. What are the equivalent annual costs of each machine? Which machine should Alexander Industries select?

11.You are bidding on a contract to supply 100,000 scarves per year for the next 3 years. To pursue this project, you must purchase $10,000 in new equipment today, which you will depreciate straight-line to zero over 3 years. The cost to you is $5.00 per scarf plus $20,000 per year in fixed costs. The project requires no additional net working capital investment and there is no salvage value for the equipment you will purchase. You have a required return of 10% on this project. Your marginal tax rate is 30%. What should your bid price be? You may upload a file to submit your answer.

Answer 1

2. Scenario analysis deals with working with more than one variable at a time, while the sensitivity analysis deals with changes in one variable at a time. The correct option is c.

3. When the project has unconventional cash flows i.e. the cash flows change signs more than once, there may be multiple IRRs present. The correct option is d.

4. The MIRR adds a reinvestment rate for the multiple cash outflows thereby helping in dealing with the unconventional cash flows. The correct option is c.

5. When new projects are added, the cash flows flom the project are the incremental cash flows. The correct option is b.

6. At the crossover point, the NPVs of both the projects are equal. However, NPV may not be zero. The correct option is b.