Gitman IM Ch09

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Solutions to Problems

Note to instructor: In most problems involving the IRR calculation, a financial calculator has been used.
P9-1.

LG 1: Payback period
Basic
a. $42,000 ÷ $7,000 = 6 years
b. The company should accept the project, since 6 < 8.

P9-2.

LG 1: Payback comparisons
Intermediate
a. Machine 1: $14,000 ÷ $3,000 = 4 years, 8 months
Machine 2: $21,000 ÷ $4,000 = 5 years, 3 months
b. Only Machine 1 has a payback faster than 5 years and is acceptable.
c. The firm will accept the first machine because the payback period of 4 years, 8 months is less than the 5-year maximum payback required by Nova Products.
d. Machine 2 has returns that last 20 years while Machine 1 has only seven years of returns.
Payback cannot consider this difference; it ignores all cash inflows beyond the payback period. In this case, the total cash flow from Machine 1 is $59,000 ($80,000 − $21,000) less than Machine 2.

P9-3.

LG 1: Personal finance: Long-term investment decisions, payback period
a. and b.
Project A

c.

Cumulative
Cash Flow

Project B

Year

Annual
Cash Flow

Annual
Cash Flow

Cumulative
Cash Flow

0
1
2
3
4
5
Total Cash Flow
Payback Period

$(9,000)
$(9,000)
$(9,000)
$(9,000)
2,00
(6,800)
1,500
(9,000)
2,500
(4,300)
1,500
(6,000)
2,500
(1,800)
1,500
(4,500)
2,000
3,500
(1,000)
1,800
4,000
11,000
12,000
3 + 1,800/2,000 = 3.9 years
4 + 1,000/4,000 = 4.25 years

The payback method would select Project A since its payback of 3.9 years is lower than
Project B’s payback of 4.25 years.

d. One weakness of the payback method is that it disregards expected future cash flows as in the case of Project B.

Chapter 9

P9-4.

LG 2: NPV
Basic
PVn = PMT × (PVIFA14%,20 yrs) NPV = PVn − Initial investment
NPV = $13,246 − $10,000
a. PVn = $2,000 × 6.623
NPV = $3,246
PVn = $13,246
Calculator solution: $3,246.26
Accept
b. PVn = $3,000 × 6.623
PVn = $19,869

c.

P9-5.

Capital Budgeting Techniques: Certainty and Risk

PVn = $5,000 × 6.623
PVn = $33,115

NPV = $19,869 − $25,000
NPV =