Capital Investment Analysis Exercises
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ScribdTranslationsCapital Investment Analysis Exercises
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ScribdTranslationsMaster of Science, Major in Civil Engineering Construction Finance
Capital Investment Analysis Exercises
Capital Investment Analysis Exercises
1. Consider the following three investments:
A: (-6,000; 10,000)
B: (-2,800; 5,000)
C: (-10,000; 11,000)
Where, in each investment, the first flow occurs now and the second flow occurs a year later.
Assume the discount rate is 20%.
a. Calculate the NPV and IRR of each investment
b. Which investment is worth more?
c. Assuming the three investments are mutually exclusive, which one would you choose?
2. As a winner of a TV show, you can choose one of the following prizes: a. $50,000 now
b. $100,000 after 6 years
c. $15,000 each year for 5 years, starting one year from now.
d. $10,000 each year for 10 years, starting one year from now.
If the discount rate is 10%. Which award would you choose?
3. A company purchases a machine for $500,000 and depreciates it on a straight-line basis over a 5-
year period for tax purposes. The investment will result in cash savings of $200,000 annually,
before taxes, for 5 years. At the end of 5 years it is estimated that the machine will sell for
$75,000. The profit from the sale of the machine will be taxed at an income tax rate of 40%. In
economic terms, is the investment in the machine attractive, considering all the cash flows?
Assume that cash flows occur at the end of each year, that the tax rate is 40%, and that the
appropriate discount rate is 8%. What is the net present value, IRR, capital payback period?
4. Smith Co. is considering replacing three manual loading machines with one automatic loading
machine. The three machines are 3 years old and were purchased at a total cost of 300,000
euros. The useful life of the machines at the time of purchase was estimated at 15 years. The
salvage value at the end of 15 years was estimated at zero.
Smith Co. can continue using the three hand-loading machines for the remaining 12 years. The
machines will continue to depreciate at a rate of €20,000 per year (the original €300,000 divided
by the 15-year useful life). Depreciation expenses will reduce taxable income and, consequently,
tax payments. Their tax rate is 40%.
Alternatively, Smith Co can replace the current three machines with one automatic machine. The
new machine would have the same capacity as the combined capacity of the three existing
machines, would have a useful life of 12 years, would be depreciated for tax purposes at a rate of
€40,000 per year for 12 years, and would have a salvage value of zero. The cost of the automatic
machine is 480,000 euros, and its use will result in labor savings of 135,000 euros per year
(before taxes). Additional savings are estimated at 25,000 euros per year (before taxes).
If Smith acquires the automatic machine, he will sell the three existing machines immediately for a
price of 100,000 euros. Inflation is not anticipated. Smith Co uses a discount rate of 7% to
evaluate its cost reduction projects. Is the investment in the new machine economically attractive?
5. Hans Frank owns a concession stand in a stadium, where he sells hot dogs, peanuts, popcorn
and soda. He still has three years left on his contract and does not expect it to be renewed
because the stadium will be demolished. The large influx of customers to his store causes long
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Master of Science, Major in Civil Engineering Construction Finance
Capital Investment Analysis Exercises
queues that limit his sales and profits, so Hans has developed 4 different proposals to make it
possible to serve more customers and increase his profits.
The first proposal is to update its equipment to speed up the service. The second is to add a new
customer service window. He could do both renovation projects if he wanted to. The third and
fourth proposals involved moving to a larger store. He could build a new store (his third proposal),
or rent a larger store in the stadium (his fourth proposal). The rental would require an initial
investment to install the equipment and place new signs. Your net income from this strategy
would be fixed after the first year because the rent payment was fixed in relation to income.
Hans was willing to invest up to $125,000 in the store and decided that a 15% discount rate was
appropriate. The incremental cash flows associated with
Each proposal was:
Project Investment Year 1 Year 2 Year 3
Upgrade existing ($ 50,000) 23,000 24,000 25,000
equipment
(75,000) 44,000 46,000 48,000
Add a new window
(125,000) 70,000 73,500 77,000
Build a new store
(15,000) 12,000 12,000 12,000
Rent a larger store
For each of these proposals, calculate the capital recovery period, the internal rate of return and
the net present value.
Using the capital recovery period as a criterion, what proposal would you recommend? Using
IRR? Using the NPV? Why do the rankings differ? What should Hans do?
6. Synerdyne is considering an investment in 2013 of $1,800,000 in equipment to support an
expansion of sales. The table below provides sales and profit projections for the project in
thousands of dollars.
2014 2015 2016 2017 2018 2019 2020
Sales 5,882 10,393 10,687 10,988 11,298 11,616 0
Utilities before of -408 1,026 1,083 1,113 1,145 1,177 0
interest, depreciation and
taxes
Depreciation -300 -300 -300 -300 -300 -300 0
Utilities before of -708 726 783 813 845 877 0
interest and taxes
Taxes at 40% +283 -290 -313 -325 -338 -351 0
Utilities before of -425 436 470 488 507 526 0
interests
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Master of Science, Major in Civil Engineering Construction Finance
Capital
Investment Analysis Exercises
Because the product is expected to become obsolete in 6 years, the investment is fully depreciated at a
rate of $300,000 per year. Sales are forecast to reach $0 in 2020, so the equipment will sell for an
estimated $250,000 by the end of 2019. The profit from such a sale is subject to a tax rate of 40%.
Net working capital at the end of each year is estimated at 12% of that year's sales. It is expected to be
fully recovered by the end of 2019.
2013 2014 2015 2016 2017 2018 2019 2020
Sales 0 5,882 10,393 10,687 10,988 11,298 11,616 0
Net working capital (12% 0 706 1,247 1,282 1,319 1,356 1,394 0
of sales)
Synerdyne uses a 14% discount rate on expansion projects.
• What are the free cash flows for each year?
• What is the NPV of the project?
• Is the project economically attractive?
