Consider a hypothetical economy that has NO tax. ABC Ltd. is considering investing in a 2-year project which is expected to generate the following year-end cash flows: C1 = $110 million, C2 = $115 million. The yearly discount rate for the project is 10%. The initial cost of the project is $200 million. (a) Compute the profit and NPV of the project. (b) Based on the answer of part (a), should the project be accepted? Explain. (c) ABC’s cut-off period is 2 years. Compute the PI and Payback of the project. Based on these two methods, should ABC accept the project?
Consider a hypothetical economy that has NO tax.
ABC Ltd. is considering investing in a 2-year project which is expected to generate the following
year-end cash flows: C1 = $110 million, C2 = $115 million. The yearly discount rate for the project
is 10%. The initial cost of the project is $200 million.
(a) Compute the profit and NPV of the project.
(b) Based on the answer of part (a), should the project be accepted? Explain.
(c) ABC’s cut-off period is 2 years. Compute the PI and Payback of the project. Based on these
two methods, should ABC accept the project?
(d) Write down the numerical formula for computing the
minimum IRR value that would make this project acceptable? Explain.
(e) Given the recommendations based on the four decision rules above, which project should
ABC Ltd. accept?
(f) Now suppose that of the $200m initial expenditure, $50m was used for the purchase of a
machine that has an estimated economic life of four years. The machine will be fully
depreciated (i.e., zero book value at the end of the machine’s economic life) on a straight-line
basis and expected to have a resale value of $35m at the end of the project.
(i) Explain how this will affect the size of the terminal (end-of-project) cash flows.
(ii) How will this affect the NPV and the acceptance/rejection of the project (as compared
to part (a))? Show your calculations.
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