Prject Analysis Under Certainty Answers to Review Questions

CHAPTER 6

PRJECT ANALYSIS UNDER CERTAINTY

ANSWERS TO REVIEW QUESTIONS

QUESTIONS

1. Explain and define the terms: net present value, internal rate of return, modified internal rate of return, accounting rate of return, and payback period.

1. Explain the role of ‘certainty’ in project evaluation decisions.

1. Assume that Anvil Inc. has estimated the following annual data for the introduction of a new product, Ranch Hand:

                       EOY 0      EOY 1      EOY 2      EOY 3     EOY 4      EOY 5

Cash Flows   -14,250     3,700        2,980         6,540       7,810         6,320

Accounting

Income                            2,870       2,540         5,890       6,720         5,780

Required rate of return: 14%pa.

Reinvestment rate of return:  12% pa.

1. For Ranch Hand calculate NPV, IRR, MIRR, ARR, and payback period.
2. Based on the calculations in part (a), make a recommendation to Anvil’s management about the introduction of Ranch Hand.

1. With respect to investment decisions, explain the terms: mutual exclusivity, replacement decisions, retirement decisions.

1. Discuss the difference in the usage of the terms ‘ asset replacement’ and ‘asset replication’.

1. The formula to arrive at an NPV for asset replication in perpetuity is:

               [pic 1]    or  [pic 2]

               [pic 3]        

[pic 4]        

Explain how this formula works, and show how it can be set up as a generic calculation within an Excel spreadsheet.

1. Assume that White Knuckle Airlines Inc. operates a regional fifty-seat jet aircraft fleet. White Knuckle expects that there will be a constant demand for this type of flight service, and that the model of aircraft employed will remain in production for the foreseeable future. White Knuckle has predicted the set of operational cash flows shown in Table 6.11 for each aircraft.

Table 6.11. Operational cash flows

    Year                  Annual Net Cash Flows $M             Salvage Value $M

       0                                 23.00 (cost)

       1                                  4.865                                          21.0

       2                                  3.956                                          18.7

       3                                  2.875                                          16.1

       4                                  2.115                                          14.3