8/13/2019 Solutions Ch 3
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1% 2% 3%
1 A1B(1C5/#)D/# .F .81
2 .F .71 .9;
3 .81 .9# .1:
9. %irm has a capital bu!"et o% /1 which must be spent on one o%
twoprojects0 each reGuirin" a present outlay o% /1. 3roject yiel!s
a return o%/1# a%ter one year0 whereas 3roject 5 yiel!s /#1.19
a%ter : years.alculate&
(i) the '3< o% each project usin" a !iscount rate o% 1=H(ii)
the I o% each project.
What are the project ranin"s on the basis o% these two
investment !ecisionrules? *uppose that you are tol! that the %irmJs
reinvestment rate is 1#=0which project shoul! the %irm choose?
Answer:(i)#P$(A) 1.'1; #P$(,) *.516 ,7A(ii) !%%(A) *'; !%%(,)
&06 A7,8sing a reinvestment rate of &* the terminal values
are 9$(A) &55.5*; 9$(,)
*'&.&6 hence ,7A. Alternatively calculate the !%% of
(,A): !%%(,A) &2.+5 7&*6 hence underta"e the etra roject
(,A) ie. underta"e ,.
:. %irm has a capital bu!"et o% /1 which must be spent on one o%
twoprojects0 with any unspent balance bein" place! in a ban !eposit
earnin"1:=. 3roject involves a present outlay o% /1 an! yiel!s
/;#1.87 a%ter :years. 3roject 5 involves a present outlay o% /9 an!
yiel!s /# a%ter oneyear. alculate&
(i) the I o% each projectH(ii) the 5B ratio o% each project0
usin" a 1:= !iscount rate.
What are the project ranin"s on the basis o% these investment
!ecisionrules? *uppose that i% 3roject 5 is un!ertaen its bene%it
can be reinveste! at18=H what project shoul! the %irm choose? *how
your calculations(sprea!sheet printout is acceptable as lon" as
entries are clearly labelle!).
Answer:
(i)!%%(A) *-.2; !%%(,) &2'6 ,7A(ii),
8/13/2019 Solutions Ch 3
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7. %irm has a capital bu!"et o% /;0 an! is consi!erin" three
possiblein!epen!ent projects. 3roject has a present outlay o% /1#0
an! yiel!s/90 #F1 per annum %or : years. 3roject 5 has a present
outlay o% /10 an!yiel!s /901F9 per annum %or : years. 3roject has a
present outlay o%/180 an! yiel!s /:0F# per annum %or 1 years. ,un!s
which are notallocate! to one o% the projects can be place! in a
ban !eposit where theywill earn 1:=.
(a) I!enti%y six combinations o% project investments an! a ban
!eposit whichexhaust the bu!"et.
(b) Which o% the above combinations shoul! the %irm
choose&(i) when the reinvestment rate is 1:=?(ii) when the
reinvestment rate is #=?
Explain your answer an! show your calculations (sprea!sheet
printout isacceptable as lon" as entries are clearly labelle!).
Answer:
9o answer these =uestions it is robably best to comare future
values after&' years6 bearing in mind that rojects with a 0year
life will have terminalvalue after 0 years which needs to comounded
forward at the reinvestmentrate (&0 and *') to year &'6 and
the residual deosited in the ban" isalways comounded over &'
years at a &0 interest rate.
>uture values are as follows: &0 *'
A?@&56''' in ban" @&2'65+- @&0*6'1*,? @*'6''' in
ban" @&2+6-0* @&05625+
