Chapter 5 Questions

Sample Answer

Question 1

1	Average Book Value and EBIT for Each Year
	Year	Opening Book Value (A)	Annual Depreciation [(25 – 10)/5] (B)	Closing Book Value (C = A – B)	Average Book Value [(A+C)/2]	Annual Revenue	Cost of Goods Sold	Annual Depreciation
	1	25	3	22	23.5	20	10	3
	2	22	3	19	20.5	22	11	3
	3	19	3	16	17.5	24.2	12.1	3
	4	16	3	13	14.5	26.62	13.31	3
	5	13	3	10	11.5	29.28	14.64	3

2	Pre-Tax Rate of Return, By Year and Average
	Year	EBIT	Average Book Value	Pre Tax rate of return 9ebit/ Average Book Value)
	1	7	23.5	29.79%
	2	8	20.5	39.02%
	3	9.1	17.5	52%
	4	10.31	14.5	71.10%
	5	11.64	11.5	101.23%
			Average	58.63%

3	EAT
	Year	EBIT	Tax	EAT (EBIT – Tax)
	1	7	2.8	4.2
	2	8	3.2	4.8
	3	9.1	3.64	5.46
	4	10.31	4.12	6.19
	5	11.64	4.66	6.98

4	After-Tax Rate of Return, By Year and Average
	Year	EAT	Average Book Value	After-Tax Rate of Return (EAT/Average Book Value*100)
	1	4.2	23.5	17.87%
	2	4.8	20.5	23.41%
	3	5.46	17.5	31.20%
	4	6.19	14.5	42.66%
	5	6.98	11.5	60.74%
			Average	35.18%

Question 12


Year	Project A	Project B	Project C	PVIF @12%	Project A	Project B	Project C
	A	B	C	D	A*D	B*D	C*D
0	-10,000	5,000	-15,000	1	-10,000.00	5,000.00	-15,000.00
1	8,000	5,000	10,000	1	7,142.86	4,464.29	8,928.57
2	7,000	-8,000	10,000	1	5,580.36	-6,377.55	7,971.94

IRR	32.74%	-13.99%	21.53%

Net Present Value					2,723.21	3,086.73	1900.51

Question 16

Question 16
EBIT	3,000,000
Less depreciation	500,000
Profit before Tax	2,500,000
Less Tax	1,000,000
Net Income	1,500,000
Add Depreciation	500,000
Operating cash Inflows	2,000,000

	Year	Operating Cashflows	Investment	Total Cashflows	PV	Present Value
	0	0	-20,000,000	-20,000,000	1	-20,000,000
	1	2,000,000	0	2,000,000	1	1,777,777.78
	2	2,000,000	0	2,000,000	1	1,580,246.91
	3	2,000,000	0	2,000,000	1	1,404,663.92
	4	2,000,000	0	2,000,000	1	1,248,590.15
	5	2,000,000	0	2,000,000	1	1,109,857.91
	6	2,000,000	0	2,000,000	0	986,540.37
	7	2,000,000	0	2,000,000	0	876,924.77
	8	2,000,000	0	2,000,000	0	779,488.69
	9	2,000,000	0	2,000,000	0	692,878.83
	10	2,000,000	0	2,000,000	0	-923,838.44
	11	2,000,000	0	2,000,000	0	547,459.82
	12	2,000,000	0	2,000,000	0	486,630.95
	13	2,000,000	0	2,000,000	0	432,560.84
	14	2,000,000	0	2,000,000	0	384,498.53
	15	2,000,000	0	2,000,000	0	341,776.47
	16	2,000,000	0	2,000,000	0	303,801.31
	17	2,000,000	0	2,000,000	0	270,045.61
	18	2,000,000	0	2,000,000	0	240,040.54
	19	2,000,000	0	2,000,000	0	213,369.37
	20	2,000,000	0	2,000,000	0	284,492.49
	21	2,000,000	0	2,000,000	0	168,588.14
	22	2,000,000	0	2,000,000	0	149,856.13
	23	2,000,000	0	2,000,000	0	133,205.45
	24	2,000,000	0	2,000,000	0	118,404.84
	25	2,000,000	0	2,000,000	0	105,248.75
	26	2,000,000	0	2,000,000	0	93,554.44
	27	2,000,000	0	2,000,000	0	83,159.50
	28	2,000,000	0	2,000,000	0	73,919.56
	29	2,000,000	0	2,000,000	0	65,706.27
	30	2,000,000	0	2,000,000	0	496,447.41
				Net Present Value		-6,043,087.68

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Week Four – Chapter 5 Questions

Select three formula-driven-problems from the Chapter 5 that you wish to showcase and prepare a Microsoft Excel document showing the Excel formulas used to prepare the solution for those problems.

Chapter 5 Questions

REMINDER: Part of the grade that you receive on your problems is the utilization of Formulas. Therefore, do not pick problems that only require a narrative!

Question 1

You have been given the following information on a project:

It has a five-year lifetime
The initial investment in the project will be $25 million, and the investment will be depreciated straightline, down to a salvage value of $10 million at the endof the fifth year.
The revenues are expected to be $20 million nextyear and to grow 10% a year after that for the remaining four years.
The cost of goods sold, excluding depreciation, is expected to be 50% of revenues.
The tax rate is 40%.

Estimate the pretax return on capital, by year and on average, for the project.
Estimate the after-tax return on capital, by year and on average, for the project.
If the firm faced a cost of capital of 12%, should it take this project?

Question 12

You have a project that does not require an initial investment but has its expenses spread over the life of the project. Can the IRR be estimated for this project? Why or why not?

Question 16

You are analyzing a project with a thirty-year lifetime, with the following characteristics:

The project will require an initial investment of $20 million and additional investments of $5 million in year 10 and $5 million in year 20.
The project will generate earnings before interest and taxes of $3 million each (The tax rate is 40%.)
The depreciation will amount to $500,000 each year, and the salvage value of the equipment will be equal to the remaining book value at the end of year 30.
The cost of capital is 12.5%.

Estimate the NPV of this project.
Estimate the IRR on this project. What might be some of the problems in estimating the IRR for this project?

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