FIN 515 Devry entire course DEVRY FIN 515 Week 3 Problem Set | Page 2
21. 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?
b. Which investment has the higher NPV when the cost of capital is 7%?
c. In this case, for what values of the cost of capital does picking the higher IRR
give the correct answer as to which investment is the best opportunity?
Chapter 8 (260–262)
1. Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of
its pizza that will be low in cholesterol and contain no trans fats. The firm expects
that sales of the new pizza will be $20 million per year. While many of these sales
will be to new customers, Pisa Pizza estimates that 40% will come from customers
who switch to the new, healthier pizza instead of buying the original version.
a. Assume customers will spend the same amount on either version. What level of
incremental sales is associated with introducing the new pizza?
b. Suppose that 50% of the customers who will switch from Pisa Pizza’s original pizza
to its healthier pizza will switch to another brand if Pisa Pizza does not introduce a
healthier pizza. What level of incremental sales is associated with introducing the
new pizza in this case?
6. Cellular Access, Inc. is a cellular telephone service provider that reported net
income of $250 million for the most recent fiscal year. The firm had depreciation
expenses of $100 million, capital expenditures of $200 million, and no interest
expenses. Working capital increased by $10 million. Calculate the free cash flow for
Cellular Access for the most recent fiscal year.
12. A bicycle manufacturer currently produces 300,000 units a year and expects
output levels to remain steady in the future. It buys chains from an outside supplier
at a price of $2 a chain. The plant manager believes that it would be cheaper to make
these chains rather than buy them. Direct in-house production costs are estimated to
be only $1.50 per chain. The necessary machinery would cost $250,000 and would be
obsolete after 10 years. This investment could be depreciated to zero for tax
purposes using a 10-year straight-line depreciation schedule. The plant manager
estimates that the operation would require $50,000 of inventory and other working
capital upfront (year 0), but argues that this sum can be ignored because it is
recoverable at the end of the 10 years. Expected proceeds from scrapping the
machinery after 10 years are $20,000.