Question 1

Given

• Hurdle rate = 10%, Use incremental IRR (internal rate of return) analysis to identify which one of the above mutually exclusive projects will be chosen?

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Question 2

Maple Media is considering a proposal to enter a new line of business. In reviewing the proposal, the company’s CFO is considering the following facts:

• The new business will require the company to purchase additional fixed assets that will cost $600,000 at t = 0. For tax and accounting purposes, these costs will be depreciated on a straight-line basis over three years. (Annual depreciation will be $200,000 per year at t = 1, 2, and 3.)
• The project will require a $50,000 increase in net operating working capital at t = 0, which will be recovered at t = 3.
• The company’s marginal tax rate is 35 percent.
• The new business is expected to generate $2 million in sales each year (at t = 1, 2, and 3). The operating costs excluding depreciation are expected to be $1.4 million per year. The project’s cost of capital is 12 percent.

What is the project’s net present value (NPV)?

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Question 3

Buckeye Books is considering opening a new production facility in Toronto, Ontario. In deciding whether to proceed with the project, the company has accumulated the following information:

• The decision to open the new facility is to some extent based on favorable marketing research. The research has uncovered that in the next 5 years the Toronto area may account for up to 15% of Buckeye’s entire sales. The research project was completed at a cost of $1 million last year.
• The same marketing research suggests that the sales of the company’s other production facility in neighboring Kingston, ON, will drop by $500,000 a year as a result of the new production line in Toronto as long as the new facility is in operation.
• The estimated immediate, up-front cost of constructing the new facility is $10 million. For tax purposes this facility will be part of a CCA class that depreciates assets at a rate of 15% per year.
• The company plans to operate the Toronto facility for 5 years. It estimates today 5 that the facility’s salvage value in 5 years will be $3 million.
• If the facility is opened, Buckeye will have to increase its inventory immediately by $2 million, and by an additional $1 million at the end of each of the first two years. In addition, its accounts payable will increase immediately by $1 million and by another $1.5 million in one year’s time. No further changes of the company’s net operating working capital requirements are expected until the end of the project at which time all net operating working capital increases will be recovered.
• If the new facility is opened, the company’s sales will increase by $7 million in the first year. However, due to high competition, these incremental sales are expected to decline by 2% each year for the remainder of the project’s life. It is assumed that all cash flows will occur at the end of each year.
• The operating costs (excluding CCA) of the new facility are expected to be $3 million in the first year. Due to rising input costs in this sector of the economy, costs are expected to inflate by 3% per year over the project’s life. It is also assumed that these cash flows will occur at the end of each year.
• The company’s tax rate is 40 percent. Buckeye’s estimated cost of capital for projects of this risk is 12 percent. Buckeye is profitable enough to fully benefit from all CCA deductions.

What is the NPV of this project?

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