Payback Period

1. Gander, Inc. is considering two projects with the following cash flows.

Year Project X Project Y

0 ($100,000) ($100,000)

1 40,000 50,000

2 40.000 0

3 40,000 0

4 40,000 0

5 40,000 250,000

1. Gander uses the payback period method of capital budgeting and accepts only projects with payback
periods of 3 years or less.

a. If the projects are presented as standalone opportunities which one(s) would

Gander accept? If they were mutually exclusive and Gander disregarded its

three year rule, which project would be chosen?

b. Is there a flaw in the thinking behind the correct answers to part a?

Net Present Value (NPV)

Profitability Index

2. A project has the following cash flows

C0 C1 C2 C3

($700) $200 $500 $244

1. What is the project’s payback period?

2. Calculate the projects NPV at 12%.
3. Calculate the project’s PI at 12%.

3. Calculate the NPV for the following projects. a. An outflow of

$7,000 followed by inflows of $3,000, $2,500 and $3,500 at one-year intervals at a cost of capital of
7% b.An initial outlay of $35,400 followed by
inflows of $6,500 for three years and then a single inflow in the fourth year of $18,000 at a cost of
capital of 9%. (Recognize the first three inflows as an annuity in your calculations.)
c. An initial outlay of $27,500 followed by an inflow of $3,000 followed by five
years of inflows of $5,500 at a cost of capital of 10%. (Recognize the last five inflows as an annuity,
but notice that it requires a treatment different from the annuity in part b.
Problem 1

A four-year project has cash flows before taxes and depreciation of $12,000 per year. The project
requires the purchase of a $50,000 asset that will be depreciated over five years, straight line. At the
end of the fourth year the asset will be sold for $18,000. The firm's marginal tax rate is 35%. Calculate
the Year 4 cash flows associated with the project. (For convenience assume the gain on the sale of the
asset is taxed at 35%.)

Problem 2

The Ebitts Field Corp. manufactures baseball gloves. Charlie Botz, the company's top salesman, has
recommended expanding into the baseball bat business. He has put together a project proposal
including the following information in support of his idea.

 New production equipment will cost $75,000, and will be depreciated straight line over five years.
 Overheads and expenses associated with the project are estimated at $20,000 per year during the
first two years and $40,000 per year thereafter.
 There is enough unused space in the factory for the bat project. The space has no alternative use or
value.
 Setting up production and establishing distribution channels before getting started will cost
$300,000 (tax deductible).
 Aluminum and Wood bats will be produced and sold to sporting goods retailers. Wholesale prices
and incremental costs per unit (direct labor and materials) are as follows:

Aluminum Wood

Price $18 $12

Cost 11 9

Gross Margin $ 7 $3

Charlie provides the following unit sales forecast is (000):

Year 1 2 3 4 5 6

Aluminum 6 9 15 18 20 22

Wood 8 12 14 20 22 24

 The sixth year sales level is expected to hold indefinitely.

 Receivables will be collected in 30 days, inventories will be the cost of one month's production, and
payables are expected to be half of inventories. Assume no additional cash or accruals are
necessary. (Use 1/12 of the current year's revenue and cost for receivables and inventory.)

Ebitts Field's marginal tax rate is 35% and its cost of capital is 12%.

1. Compute for the company gross margins for Years 5 & 6. (10 pts.)
2. How much is the increase in working capital in Year 4? (5 pts.)
3. How much is the initial cash outlay required for the project? (5 pts.)
4. How much is the Net Cash Flow in Year 4? (5 pts.)