Principles of Finance
SAMPLE SECOND QUIZ
Do all the problems. Include calculations and/or explanations in your answers wherever appropriate. More credit will be given for correct reasoning than for correct arithmetic.
- Alpha is considering Project A with a cost of capital 6%. Its cash flows are:
A: -$1,000, $277, $277, $277, $277, $277.
(a) Calculate its NPV at 6% and its IRR. $167 and 12%
(b) Sketch its NPV profile.
2. Beta Company is investigating project B, which has a cost of capital of 16%.
B: -$16,000, $6,000, $6,000, $8,000.
(a) Calculate the NPV. -$1,243 Is project B acceptable?
(b) What does your answer to part (a) say about the IRR of project B. Why?
3. Gamma Co. is considering project C.
C: $5,000, $4,000, $7,000, -$8,000, -$10,000
C’s cost of capital is 8%, and the spread sheet says that its IRR is 5.0% but its NPV at 8% is $1004.12. Should Gamma take the project, even though the IRR is less than the cost of capital? Explain.
4. You have been planning for retirement for several years and are now 35 with $60,000 in your plan earning an expected 6%. You are thinking of retiring at 68 with an estimated 25 years of retirement. At retirement you will switch to lower risk, lower expected return investments for an expected 4% rate of return in retirement.
(a) You want a retirement income of $75,000 per year. How much must you contribute per year during the accumulation period? $7,820 to save the $1,171,656 needed at retirement
(b) How much will your $60,000 grow to become at retirement? $410,435
(c) If a bad week in the market destroys 30% of that $60,000 how much would you have to contribute to make up for it? $9,085 or $1,265 more to save up the $1,171,656 needed at retirement.
(d) If instead of increasing your contributions you are thinking of retiring later, would two extra years of working make up for the loss (in the sense that you could retire with at least $75,000 per year)? Yes, with retirement two years shorter.