Virginia Hampton
FIT BUSN 5431
Week 7 Homework Problems
Chapter 9.
Problem 9-1. James Hardy – Vancouver Seals
Present Value Analysis
Required: Suppose you are Hardy’s agent and you want to evaluate the two contract options using a required rate of return of 15 percent. In present value terms, how much better is the second contract?
Solution:
The second contract is not as good a deal as the first when the time value of money is taken into account. The original contract was worth $15,880,500 in present value terms whereas the new option is worth $13,184,230.
Original Contract
Cash 15% PV
Time Flow Factor Total
0 $7,500,000 1.000 $7,500,000
1-5 2,500,000 3.3522 8,380,000
$15,880,500
New Contract
Cash 15% PV
Time Flow Factors Total
1 $2,500,000 0.8696 $2,174,000
2 2,600,000 0.7561 1,965,860
3 2,700,000 0.6575 1,775,250
4 2,800,000 0.5718 1,601,040
5 2,900,000 0.4972 1,441,880
5 (balloon) 8,500,000 0.4972 4,226,200
Total $13,184,230
Problem 9-3. Albert Shoe Company
Choosing among alternative investments
Required: Determine the NPV for each machine and decide which should be purchased if the required rate of return is 13 percent. (Ignore taxes).
Solution:
Cash 13% PV
Machine A Flow Factors PV Amounts
Cost of Machine ($70,000) 1.0000 ($70,000)
Annual Savings 20,000 3.9975 79,950
Net Present Value $9,950
Cash 13% PV
Machine B Flow Factors PV Amounts
Cost of Machine ($95,000) 1.0000 ($95,000)
Annual Savings 25,000 3.9975 99,938
Net Present Value $ 4,938
The company should buy Machine...