Finance 515 Week 5

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HW week 5 04/06/14 7-20 Payback and NPV Problems (p. 228) You are considering making a movie. The movie is expected to cost $10 million upfront and take a year to make. After that, it is expected to make $5 million when it is released in one year and $2 million per year for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have positive NPV if the cost of capital is 10%? *It will take 5 years to payback the investment. Therefore, will not make the movie. See below. Example Problems | Find the NPV for the following Capital Budgeting project. | Year | | Cash Flow | | 0 | $ | -10 | | 1 | $ | 5 | | 2 | $ | 2 | | 3 | $ | 2 | | 4 | $ | 2 | | 5 | $ | 2 | | Cost of Capital: | | 10 | % | NPV: | $ | 0.31 | | | (cost done in millions) (http://www.zenwealth.com/businessfinanceonline/CB/NetPresentValue.html) 7-21 NPVs and IRR's for Mutually Exclusive Projects You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of $10 million. Investment A will generate $2 million per year (starting at the end of the first year) in perpetuity. Investment B will generate $1.5 million at the end of the first year and its revenues will grow at 2% per year for every year after that. a. Which investment has the higher IRR? i. The IRR for A is 20% and the IRR for B is 17%. Thus you pick the larger IRR b. Which investment has the higher NPV when the cost of capital is 7%? ii. Revenues=.07 iii. Investment A= $18.5 million iv. Investment B= $20 million v. Thus, when the cost of capital is higher at 7% the better choice is investment B. c. In this case, for what values of the cost of capital does picking

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