Financial Management Assignment 5

1. Understanding internal rate of return

A one period investment requires an outlay of 100 today and will generate $120 a year later. The required rate of return for the investment is 10%.

1. 1. What is the NPV for the investment?
   2. What is the internal rate of return for the investment?
   3. Comments on the difference between the required rate of return and internal rate of return?

       

1. Capital budgeting

An investment requires an outlay of $100,000 today. Cash inflow from the investment are expected to be $40,000 per year at the end of year 4, 5, 6, 7, and 8. You require a 20% rate of return on this type of investment. Answer the following questions:

1. 1. First draw the time line and specify the cash outflow and inflow for each period.
   2. Calculate the net present value.
   3. Calculate the Internal rate of return of this investment.
   4. Calculate the payback periods
   5. Shall the investment be undertaken?

1. Capital budgeting decision on new branch

• Initial cost of building and equipment is $1 million
• Expected to have a useful life of 20 years
• At the end of the project the building and its equipment are expected to be sold for a $200,000 salvage value
• The building and its equipment will be depreciated over their 20-year life using straight-line depreciation to a zero balance
• The building is to be constructed on land leased for $22,000 per year
• Net working capital must be increased by $100,000
• Annual revenues from the new branch will be $400,000
• Of this $400,000 in revenues, $50,000 will be drawn away from the bank’s main office
• The new branch will incur about $130,000 per year in other expenses
• Both expenses and revenues are expected to remain approximately constant over the branch’s 20-year life
• Marginal tax rate is 40%
• Cost of capital 9%

Answer the following questions:

1. What is the cash flow for the branch’s 20-year life

1. Calculate the NPV, Profitability index, and Internal rate of return (IRR).

1. Should the project be accepted? Why?