Ben is a retired budget auditor who is currently looking for a new investment opportunity. He is considering two investments: Calzone Zone, a small restaurant specialising in calzone, and Icetown, a skating and curling rink. The projected cash flows of the two investments are shown below. Ben can only choose one projects, so he asks for your help and advice in reaching a decision on which investment to accept. He tells you he requires a 5% rate of return on his investment. Calzone Icetown Zone Cash flows £000 £000 (885) 150 Initial investment (300) 215 Cash flows year 1 Cash flows year 2 Cash flows year 3 Cash flows year 4 Cash flows year 5 215 215 215 195 200 230 265 (585) Assume the initial investment arises at the start of the first year of the project and all the subsequent cash flows occur at the end of the year. Questions A. Plot the net present value of each of the projects as a function of the required rate of return. (Tip: Use spreadsheet software to calculate NPV using r of 0% - 100% and create a scatter plot) B. Critically evaluate the internal rate of return as a capital investment appraisal tool and discuss the key shortcomings specific to this method.

Ben is a retired budget auditor who is currently looking for a new investment opportunity. He is considering two investments: Calzone Zone, a small restaurant specialising in calzone, and Icetown, a skating and curling rink. The projected cash flows of the two investments are shown below. Ben can only choose one projects, so he asks for your help and advice in reaching a decision on which investment to accept. He tells you he requires a 5% rate of return on his investment. Calzone Icetown Zone Cash flows £000 £000 (885) 150 Initial investment (300) 215 Cash flows year 1 Cash flows year 2 Cash flows year 3 Cash flows year 4 Cash flows year 5 215 215 215 195 200 230 265 (585) Assume the initial investment arises at the start of the first year of the project and all the subsequent cash flows occur at the end of the year. Questions A. Plot the net present value of each of the projects as a function of the required rate of return. (Tip: Use spreadsheet software to calculate NPV using r of 0% - 100% and create a scatter plot) B. Critically evaluate the internal rate of return as a capital investment appraisal tool and discuss the key shortcomings specific to this method.

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter11: Cash Flow Estimation And Risk Analysis

Section: Chapter Questions

Problem 1aM

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Ben is a retired budget auditor who is currently looking for a new investment opportunity. He is considering two investments: Calzone Zone, a small restaurant specialising in calzone, and Icetown, a skating and curling rink. The projected cash flows of the two investments are shown below.Ben can only choose one projects, so he asks for your help and advice in reaching a decision on which investment to accept. He tells you he requires a 5% rate of return on his investment. Calzone ZoneIcetownCash flows£000£000Initial investment(885)(300)Cash flows year 1150215Cash flows year 2195215Cash flows year 3200215Cash flows year 4230215Cash flows year 5265(585)Assume the initial investment arises at the start of the first year of the project and all the subsequent cash flows occur at the end of the year. A. Calculate the net present value of each of the projects. Which project should Ben invest in? Show your workings. B. Calculate the internal rate of return of each of the projects. Which…
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