Financial Management FIN 534 Corporate Finance 2008 Custom Edition
Chapter 6 Problems 1, 9, 18
You are considering opening a new plant. The plant will cost $100
million upfront and will take one year to build. After that, it is
expected to produce profits of $30 million at the end of every year of
production. The cash flows are expected to last forever. Calculate the
NPV of this investment opportunity if your cost of capital is 8%. Should
you make the investment? Calculate the IRR and use it to determine the
maximum deviation allowable in the cost of capital estimate to leave the
9. Innovation Company is thinking about
marketing a new software product. Upfront costs to market and develop
the product are $5 million. The product is expected to generate profits
of $1 million per year for ten years. The company will have to provide
product support expected to cost $100,000 per year in perpetuity. Assume
all profits and expenses occur at the end of the year.
a. What is
the NPV of the investment if the cost of capital is 6%? Should the firm
undertake the projects? Repeat the analysis for discount rates of 2% and
b. How many IRRs does the investment opportunity have?
c. What does the IRR rule indicate about this investment?
18. You work for an outdoor play structure manufacturing company and are trying to decide between two projects:
Year-End Cash Flows ($ thousands)
Project 0 1 2 IRR
Playhouse -30 15 20 10.4%
Fort -80 39 52 8.6%
You can undertake only one project. If your cost of capital is 8%, use the incremental IRR rule to make the correct decision.