Chapter 5 Questions
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 | Pretax 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% |
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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 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 you receive on your problems is the utilization of Formulas. Therefore, do not pick issues 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 asset will be depreciated straight line, down to a salvage value of $10 million at the end of the fifth year.
- The revenues are expected to be $20 million next year 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 for the project by a year and on average.
- Estimate the after-tax return on capital for the project by a year and on average.
- 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 expenses spread over the project’s life. 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 ten 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 equipment’s salvage value will equal 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?