Tags
#analyst-notes #cfa-level-1 #corporate-finance #reading-35-capital-budgeting #study-session-10 #subject-3-investment-criteria
Question
Tom and Erdal are planning on forming the Top-Torque Company. The company is to specialize in diesel engine rebuilding for extractive industries. The investment cost is expected to be $1.5 million and have after-tax cash flows of$100,000 in year 1, $250,000 in year 2, and$300,000 thereafter indefinitely. The two owners estimate that this is a risky venture and requires a 17% rate of return. What is the value of Top-Torque, and should the investment be made?

A. $57,240; yes B.$1,557,240; yes
C. -$57,240; no Answer Correct Answer: A NPV = -1,500,000 + 100,000/1.17 + 250,000/1.172 + (300,000/.17)/1.172 = -1,500,000 + 1,557,240.04 =$57,240.04

Tags
#analyst-notes #cfa-level-1 #corporate-finance #reading-35-capital-budgeting #study-session-10 #subject-3-investment-criteria
Question
Tom and Erdal are planning on forming the Top-Torque Company. The company is to specialize in diesel engine rebuilding for extractive industries. The investment cost is expected to be $1.5 million and have after-tax cash flows of$100,000 in year 1, $250,000 in year 2, and$300,000 thereafter indefinitely. The two owners estimate that this is a risky venture and requires a 17% rate of return. What is the value of Top-Torque, and should the investment be made?

A. $57,240; yes B.$1,557,240; yes
C. -$57,240; no Answer ? Tags #analyst-notes #cfa-level-1 #corporate-finance #reading-35-capital-budgeting #study-session-10 #subject-3-investment-criteria Question Tom and Erdal are planning on forming the Top-Torque Company. The company is to specialize in diesel engine rebuilding for extractive industries. The investment cost is expected to be$1.5 million and have after-tax cash flows of $100,000 in year 1,$250,000 in year 2, and $300,000 thereafter indefinitely. The two owners estimate that this is a risky venture and requires a 17% rate of return. What is the value of Top-Torque, and should the investment be made? A.$57,240; yes
B. $1,557,240; yes C. -$57,240; no

NPV = -1,500,000 + 100,000/1.17 + 250,000/1.172 + (300,000/.17)/1.172 = -1,500,000 + 1,557,240.04 = \$57,240.04
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dy>NPV measures the dollar benefit of the project to shareholders. However, it does not measure the rate of return of the project, and thus cannot provide "safety margin" information. Safety margin refers to how much the project return could fall in percentage terms before the invested capital is at risk.<body><html>

#### Original toplevel document

Subject 3. Investment Decision Criteria
on that capital. If a firm takes on a project with a positive NPV, the position of the stockholders is improved. Decision rules: The higher the NPV, the better. Reject if NPV is less than or equal to 0. <span>NPV measures the dollar benefit of the project to shareholders. However, it does not measure the rate of return of the project, and thus cannot provide "safety margin" information. Safety margin refers to how much the project return could fall in percentage terms before the invested capital is at risk. Assuming the cost of capital for the firm is 10%, calculate each cash flow by dividing the cash flow by (1 + k) t where k is the cost of capital and t is the year number.

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