Analysis for Financial Management, 10e

SUGGESTED ANSWERS TO EVEN-NUMBERED PROBLEMS

CHAPTER 7

2. The compound annual growth rate is 12.50 percent.

Input: 11 ? -5.82 0 21.26

n i PV PMT FV
Output: 12.50

4. The monthly interest on this loan is 0.583% (7%/12). After the first 12 months with
no payments, the balance on the loan will increase to $87,924.

Input: 12 0.583 82,000 0 ?

n i PV PMT FV
Output: -87,924

To determine the size of the balloon payment at the end of the sixth year, solve for
the future value of the loan given the 5 years of monthly car payments of $1,500.
The result is a balloon payment at the end of the 6 year loan of $17,254.

Input: 60 0.583 87,924 -1500 ?

n i PV PMT FV
Output: -17,254

6. The $800 spent to date is sunk; you cannot recoup this money regardless of how the
prospective sale works out. You should be willing to spend up to an additional $1,000
if you are confident doing so will land the sale. Here is another way to look at it.
Suppose you are certain an additional expenditure of $900 will guarantee the sale.
You then have two options: 1. quit trying and lose $800 already spent, or 2. spend the
additional $900 for a total expense of $1,700, which net of the $1,000 receipt from the
sale results in a loss of $700. I’d rather lose $700 than $800.

1
© 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or
distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.
8. Applying the with/without principle, the relevant cash flows are as follows:

Year 0 1 2 3 4 5
Cash flow ($ millions) -$60 18.7 18.7 18.7 18.7 18.7

The annual cash flow with the investment is $700,000, and the annual cash flow
without the investment is -$18 million. Taking the difference, $700,000 –(-$18
million) = $18.7 million. The chief benefit of this investment is it enables the
company to avoid losing its shirt.

Input: 5 10 ? 18.7 0
n i PV PMT FV
Output: -70.89

The PV of the 5-year cash flow of $18.7 million = $70.89 million. The NPV = -$60
+ $70.89 = $10.89 million. Therefore, the campaign is attractive. It avoids a large
loss.

The important moral to this problem is that the do-nothing alternative is not always
zero. You need to think carefully about the consequences of not making an
investment. If the investment avoids a negative outcome, this is a legitimate benefit
to the investment.

10. a. Undertake all three investments. The NPV and the IRR indicate that all of the
investments are worthwhile.

b. Undertake investment A because it has the highest NPV, and NPV is a direct
measure of the increase in wealth from undertaking the investment.

c. If the capital budget is fixed at $5.5 million, invest in C and B, and put the
remaining $500,000 in A if possible. This is the bundle of investments with the
highest total NPV. One can select this bundle by ranking investments by their IRR,
or occasionally more accurately by their BCR.

12. See C7_Problem_12_Answer.xlsx on this Web site.

14. See C7_Problem_14_Answer.xlsx on this Web site.

2
© 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or
distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in
whole or part.