Union Electric Company must clean up the water released from its generating plant. The company's cost of capital is 12 percent for average risk projects, and that rate is normally adjusted up or down by 2 percentage points for high- and low- risk projects. Clean-Up Plan A . which is of average risk, has an initial cost of $10 million, and its operating cost will be $1 million per year for its 10-year life. Plan B, which is a high-risk project, has an initial cost of $5 million, and its annual operating cost over Years 1 to 10 will be $2 million. What is the approximate PV of costs for the better project?
The cash flows of Plan A are discounted at 12%, the company's cost of capital for average risk projects. Plan B is evaluated with a lower cost of capital that reflects a greater risk of the cash outflow of the project. Thus, the cash flows of Plan B are discounted at 10% (12% --- 2%). the company's adjusted cost of capital for high risk projects. The net present value of each plan is the initial cost plus the present value of an annuity for 10 years at the appropriate rate multiplied times the annual operating cost.
The present value factors are found in the tools section of CMA Test Prep.
Plan A NPV = $10,000,000 + ($1,000,000 x 5.650)
Plan A NPV = $15,650,000
Plan B NPV = $5,000,000 + ($2,000,000 x 6.145)
Plan B NPV = $17,290,000
Plan A has a lower NPV and thus is the better project.
The Hopkins Company has estimated that a proposed project's 10-year annual net cash benefit, received each year end. will be $2,500 with an additional terminal benefit of $5,000 at the end of the 10th year. Assuming that these cash inflows satisfy exactly Hopkins' required rate of return of 8%, calculate the initial cash outlay
If the 8% return exactly equals the present value of the future flows ., NPV is zero), then simply determine the present value of the future inflows. Thus, Hopkins Company's initial cash outlay is $19,090 [($2,500)(PVIFA at 8% for 10 periods) + ($5J00)(PVlF at 8% for 10 periods ($2,500)(6.710) + ($5,000)(.463)].
The accounting rate of return?
The accounting rate of return (also called the unadjusted rate of return or book value rate of return) is calculated by dividing the increase in accounting net income by the required investment. Sometimes the denominator is the average investment rather than the initial irstment This method ignores the time value of money hand focuses on income as opposed to cash flows.
The Hopkins Company has estimated that a proposed project's 10-year annual net cash benefit, received each year end. will be $2,500 with an additional terminal benefit of $5,000 at the end of the 10th year. Assuming that these cash inflows satisfy exactly Hopkins' required rate of return of 8%, calculate the initial cash outlay
If the 8% return exactly equals the present value of the future flows ., NPV is zero), then simply determine the present value of the future inflows. Thus, Hopkins Company's initial cash outlay is $19,090 [($2,500)(PVIFA at 8% for 10 periods) + ($5J00)(PVlF at 8% for 10 periods ($2,500)(6.710) + ($5,000)(.463)].
The management of Pelican, Inc. is evaluating a proposed acquisition of a new machine at a purchase price of $180,000 and with installation costs of $10,000. A $9,000 increase in working capital will be required. The machine Will have a useful life of four years, after which it can be sold for $30,000. The estimated annual incremental operating revenues and cash operating expenses are $450,000 and $300.000, respectively, for each of the four years. Pelican's effective income tax rate is 40%. and the cost of capital is 12%. Pelican uses straight-line depreciation for both financial reporting and income tax purposes. If the project is accepted, the estimated incremental after-tax operating cash flows at the end of the first year wilt be?
The estimated incremental after-tax operating cash flows for each year of a capital project consist of two components: the after-tax cash inflows from operations and the depreciation tax shield arising from me purchase of new equipment. The first of these for Pelican can be calculated as follows:
Pelican's total incremental after-tax operating cash flows for each year of the project's
life is thus $106,000 ($90,000 + $16,000).
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