SDU UNIVERSITY · Department of Finance and Economics

FIN 3121 / G216 — Fundamentals of Financial Management · Spring 2026

COMPREHENSIVE PRACTICE PROBLEM SET

36 Fully Solved Problems · One per Unique Problem Type · Chapters 8 · 9 · 10

HOW TO USE THIS DOCUMENT

This practice set contains exactly one fully worked example for each unique problem type that appeared in the
FIN 3121 / G216 Final Examination (Variants A, B, and C). Every problem is presented in the same format as
the actual exam — read the scenario, attempt the solution, then study the step-by-step working below.

Each solution shows: (1) the exact formula, (2) all intermediate steps with key values in bold, and (3) the final
answer(s) to write on the Answer Sheet. Where a problem group shares the same data (e.g., payback period
and discounted payback; NPV and IRR), an orange ANSWER SHEET NOTE box indicates which specific value
each problem number expects.

Chapters: 8 (Risk & Return) · 9 (Capital Budgeting) · 10 (Cash Flow Estimation) · Textbook: Brooks —
Financial Management: Core Concepts

CHAPTER 9 — CAPITAL BUDGETING Practice Problems 1–12

Problem 1–2 · Chapter 9 2 pts

▶ Payback Period & Discounted Payback Period

A project costs $70,000 and generates the following cash flows:

Year 1 = $20,000; Year 2 = $25,000; Year 3 = $30,000; Year 4 = $15,000.

Problem 1. Calculate the REGULAR PAYBACK PERIOD (to two decimal places).
Problem 2. Using a discount rate of 10%, calculate the DISCOUNTED PAYBACK PERIOD (to two decimal
places).

FULL SOLUTION — Formula · Steps · Answer

Formula Regular Payback Period: Accumulate undiscounted cash flows year by

(P1) year until the initial investment is recovered.
Payback = Year of full recovery + (Remaining balance at start of that year) /
(Cash flow in that year)

Step 1 Cumulative undiscounted cash flows:

 P1 After Year 1: 70,000 − 20,000 = $50,000 remaining
After Year 2: 50,000 − 25,000 = $25,000 remaining
During Year 3: 25,000 < 30,000 → payback occurs in Year 3

Step 2 Fraction of Year 3: 25,000 ÷ 30,000 = 0.833

P1 Payback Period (P1) = 2 + 0.833 = 2.83 years

Formula Discounted Payback Period: Discount each cash flow to Year 0, then
(P2) accumulate until the initial investment is recovered.
PV(Year n) = CF_n ÷ (1 + r)^n

Step 3 Discounted cash flows at 10%:

P2 PV(Y1) = 20,000 ÷ 1.10 = $18,181.82
PV(Y2) = 25,000 ÷ 1.21 = $20,661.16
PV(Y3) = 30,000 ÷ 1.331 = $22,539.44
PV(Y4) = 15,000 ÷ 1.4641 = $10,245.19

Step 4 Cumulative discounted cash flows:

P2 After Y1: 70,000 − 18,181.82 = $51,818.18 remaining
After Y2: 51,818.18 − 20,661.16 = $31,157.02 remaining
After Y3: 31,157.02 − 22,539.44 = $8,617.58 remaining
During Y4: 8,617.58 ÷ 10,245.19 = 0.841 of Year 4
Discounted Payback Period (P2) = 3 + 0.841 = 3.84 years

ANSWER SHEET NOTE: Problem 1 asks for the REGULAR PAYBACK PERIOD → write 2.83 years on the answer sheet for
Problem 1.
Problem 2 asks for the DISCOUNTED PAYBACK PERIOD → write 3.84 years on the answer sheet for Problem 2.
Both answers come from the same project data — each goes on its own answer line.

Problem 1 Answer Problem 2 Answer

WRITE ON ANSWER SHEET:
2.83 yrs 3.84 yrs

Problem 3–4 · Chapter 9 2 pts

▶ NPV & IRR (Uniform Annual Cash Flows)

A project has an initial cost of $120,000 and generates annual cash inflows of $30,000 for 6 years. The required
discount rate (hurdle rate) is 11%.

Problem 3. Calculate the NPV of this project.

Problem 4. Calculate the IRR of this project (to two decimal places as a percentage).

FULL SOLUTION — Formula · Steps · Answer

Formula NPV = PV of Future Cash Flows − Initial Investment

(P3) PV of annuity = CF × PVIFA(r, n) where PVIFA = [1 − 1/(1+r)^n] / r

Step 1 Compute PVIFA(11%, 6):

P3 (1.11)^6 = 1.8704
PVIFA = [1 − 1/1.8704] / 0.11 = [1 − 0.5346] / 0.11 = 4.2305

Step 2 PV of cash flows: 30,000 × 4.2305 = $126,916

P3 NPV (P3) = $126,916 − $120,000 = +$6,916
→ NPV > 0 → accept the project

Formula IRR is the rate r* that makes NPV = 0:

 (P4) 120,000 = 30,000 × PVIFA(r*, 6) → PVIFA(r*,6) = 120,000/30,000 = 4.0000

Step 3 Trial: r = 13%:

P4 (1.13)^6 = 2.0820
PVIFA(13%,6) = [1 − 1/2.0820] / 0.13 = [1 − 0.4803] / 0.13 = 0.5197/0.13 =
3.998 ≈ 4.000 ✓

Step 4 IRR ≈ 13.00% (verify: PV = 30,000 × 3.998 = 119,940 ≈ 120,000 ✓)

P4 Since IRR (13%) > hurdle rate (11%), the NPV-positive result is confirmed.

ANSWER SHEET NOTE: Problem 3 asks for NPV → write $6,916 (or "$6,916.39" if more precise) on the answer sheet for
Problem 3.
Problem 4 asks for IRR → write 13.00% on the answer sheet for Problem 4.
Both are computed from the same project — each answer belongs on its own answer line.

Problem 3 Answer Problem 4 Answer

WRITE ON ANSWER SHEET:
NPV = IRR = 13.00%
$6,916
 Problem 5–6 · Chapter 9 2 pts

▶ Mutually Exclusive Projects & Crossover Rate

Two mutually exclusive projects — both with initial cost $110,000:

Project Titan: Year 0 = −$110,000; Year 1 = $65,000; Year 2 = $55,000; Year 3 = $15,000
Project Nova: Year 0 = −$110,000; Year 1 = $15,000; Year 2 = $30,000; Year 3 = $110,000
Discount rate = 10%.

Problem 5. Which project has the higher NPV? (Write the NPV of the better project.)
Problem 6. Calculate the crossover rate — the IRR of the incremental cash flows (Titan minus Nova) — to one
decimal place.

FULL SOLUTION — Formula · Steps · Answer

Formula NPV = Σ [CF_t / (1+r)^t] − Initial Investment

Compute NPV for each project separately; compare; select higher NPV.

Step 1 NPV(Titan) at 10%:

Titan Y1: 65,000 ÷ 1.10 = 59,090.91
Y2: 55,000 ÷ 1.21 = 45,454.55
Y3: 15,000 ÷ 1.331 = 11,269.72
PV total = 115,815.18 → NPV(Titan) = 115,815.18 − 110,000 = $5,815

Step 2 NPV(Nova) at 10%:

Nova Y1: 15,000 ÷ 1.10 = 13,636.36
Y2: 30,000 ÷ 1.21 = 24,793.39
Y3: 110,000 ÷ 1.331 = 82,644.63
PV total = 121,074.38 → NPV(Nova) = 121,074.38 − 110,000 = $11,074

Step 3 Nova has the higher NPV → $11,074 (choose Nova over Titan at 10%)
P5

Step 4 Incremental CFs (Titan − Nova):

P6 Y0: 0 | Y1: 65,000−15,000 = +$50,000 | Y2: 55,000−30,000 = +$25,000 |
Y3: 15,000−110,000 = −$95,000

Step 5 Find IRR of incremental CFs (trial at 15%):

P6 Y1: 50,000 ÷ 1.15 = 43,478
Y2: 25,000 ÷ 1.3225 = 18,903
Y3: −95,000 ÷ 1.5209 = −62,462
Sum = 43,478 + 18,903 − 62,462 = −$81 ≈ 0 → Crossover Rate ≈ 15.0%
Interpretation: below 15%, Nova wins; above 15%, Titan wins.

ANSWER SHEET NOTE: Problem 5 asks which project has higher NPV and for that NPV → write $11,074 for Problem 5.
Problem 6 asks for the crossover rate → write 15.0% for Problem 6.
The crossover rate is sometimes called the "IRR of the difference" — both terms mean the same thing.

P5 — Better NPV P6 — Crossover Rate

WRITE ON ANSWER SHEET:
$11,074 15.0%
(Nova)

Problem 7 · Chapter 9 2 pts

 ▶ Modified Internal Rate of Return (MIRR)

A 3-year project has the following cash flows:

Year 0 = −$250,000; Year 1 = $90,000; Year 2 = $120,000; Year 3 = $150,000.
The reinvestment rate (cost of capital) = 10%.
Calculate the MIRR (as a percentage to two decimal places).

FULL SOLUTION — Formula · Steps · Answer

Formula MIRR = [TV / PV_costs]^(1/n) − 1

TV = Terminal Value: compound ALL positive CFs forward to Year n at the
reinvestment rate.
PV_costs = PV of ALL negative CFs (discounted at the reinvestment rate).
Here, only Year 0 is negative, so PV_costs = $250,000.

Step 1 Compound positive CFs to Year 3 at 10%:

TV Y1 CF: 90,000 × (1.10)² = 90,000 × 1.21 = $108,900
Y2 CF: 120,000 × (1.10)¹ = 120,000 × 1.10 = $132,000
Y3 CF: 150,000 × (1.10)⁰ = 150,000 × 1.00 = $150,000
TV = 108,900 + 132,000 + 150,000 = $390,900

Step 2 Solve for MIRR:

250,000 = 390,900 / (1 + MIRR)³
(1 + MIRR)³ = 390,900 / 250,000 = 1.5636
1 + MIRR = 1.5636^(1/3) = 1.1597
MIRR = 0.1597 = 15.97%

Check Verify: 250,000 × (1.1597)³ = 250,000 × 1.5636 = 390,900 ✓

MIRR (16.0%) > hurdle rate (10%) → accept the project.

Answer — MIRR
WRITE ON ANSWER SHEET:
15.97%

Problem 8 · Chapter 9 2 pts

▶ Profitability Index (PI)

A project costs $600,000 and will generate $180,000 annually for 5 years.
The hurdle rate is 10%.
Calculate the Profitability Index (PI) to two decimal places.

FULL SOLUTION — Formula · Steps · Answer

Formula PI = PV of Future Cash Flows / Initial Investment

PV of annuity = CF × PVIFA(r, n) where PVIFA = [1 − 1/(1+r)^n] / r

Step 1 PVIFA(10%, 5):

(1.10)^5 = 1.61051
PVIFA = [1 − 1/1.61051] / 0.10 = [1 − 0.6209] / 0.10 = 3.7908

Step 2 PV of cash flows: 180,000 × 3.7908 = $682,344

 Step 3 PI = $682,344 / $600,000 = 1.14
Since PI > 1.0, the project is acceptable.
Cross-check: NPV = 682,344 − 600,000 = $82,344 (positive ✓)

Answer — PI
WRITE ON ANSWER SHEET:
1.14
 Problem 9 · Chapter 9 2 pts

▶ Equivalent Annual Annuity (EAA)

Project Alpha (5-year life) has NPV = $15,000 at 10%.

Project Beta (4-year life) has NPV = $13,000 at 10%.
Using the Equivalent Annual Annuity (EAA) method, which project is better?
Provide the EAA of the better project (to two decimal places).

FULL SOLUTION — Formula · Steps · Answer

Formula EAA = NPV / PVIFA(r, n)

The EAA converts an NPV to an annualized value, enabling fair comparison
between projects with different lives.
Choose the project with the HIGHER EAA.

Step 1 PVIFA(10%, 5):

Alpha (1.10)^5 = 1.61051 → PVIFA = [1 − 0.6209] / 0.10 = 3.7908
EAA(Alpha) = $15,000 / 3.7908 = $3,957.14 per year

Step 2 PVIFA(10%, 4):

Beta (1.10)^4 = 1.4641 → PVIFA = [1 − 0.6830] / 0.10 = 3.1699
EAA(Beta) = $13,000 / 3.1699 = $4,101.00 per year

Step 3 Comparison:
EAA(Beta) = $4,101 > EAA(Alpha) = $3,957
Project Beta is better. Write the EAA of the better project: $4,101.00

ANSWER SHEET NOTE: The exam asks you to: (1) determine which project is better, and (2) provide the EAA of the better
project.
Both pieces of information may be expected. Write on your answer sheet:
"Project Beta is better / EAA = $4,101.00" — or simply $4,101.00 if the answer sheet has one field.
You may also show $3,957.14 (Alpha) as an intermediate — this is also a valid computed value.

Better project EAA of Beta

WRITE ON ANSWER SHEET:
Beta $4,101.00

Problem 10–11 · Chapter 9 2 pts

▶ NPV & IRR (Non-Uniform Cash Flows)

A project has the following cash flows:

Year 0 = −$75,000; Year 1 = $28,000; Year 2 = $32,000; Year 3 = $40,000.
Discount rate = 12%.

Problem 10. Calculate the NPV.

Problem 11. Calculate the IRR (to one decimal place).

FULL SOLUTION — Formula · Steps · Answer

Formula NPV = Σ [CF_t / (1+r)^t] for t = 1 to 3 minus the initial investment

 (P10) Each year's CF is discounted individually (not an annuity — CFs are not
uniform).

Step 1 Discount each CF at 12%:

P10 PV(Y1) = 28,000 ÷ 1.12 = $25,000.00
PV(Y2) = 32,000 ÷ 1.2544 = $25,509.55
PV(Y3) = 40,000 ÷ 1.404928 = $28,471.49
Sum of PVs = $78,981.04

Step 2 NPV = $78,981.04 − $75,000 = +$3,981 ✓ (Accept — NPV > 0)

P10

Formula IRR: find r* such that NPV = 0

(P11) Trial-and-error (or financial calculator): test r values until NPV flips sign.

Step 3 Trial at r = 14%:

P11 PV(Y1) = 28,000 / 1.14 = 24,561.40
PV(Y2) = 32,000 / 1.2996 = 24,622.96
PV(Y3) = 40,000 / 1.4815 = 27,002.36
Sum = 76,186.72 → NPV = 76,186.72 − 75,000 = +$1,187 (still positive →
IRR > 14%)

Step 4 Trial at r = 15%:

P11 PV(Y1) = 28,000 / 1.15 = 24,347.83
PV(Y2) = 32,000 / 1.3225 = 24,197.34
PV(Y3) = 40,000 / 1.5209 = 26,300.22
Sum = 74,845.39 → NPV = 74,845.39 − 75,000 = −$154.61 (negative →
IRR < 15%)

Step 5 Interpolation:
P11 IRR ≈ 14% + [1,187 / (1,187 + 155)] × 1% = 14% + 0.884% = 14.9%

ANSWER SHEET NOTE: Problem 10 asks for NPV → write $3,981 on the answer sheet for Problem 10.
Problem 11 asks for IRR → write 14.9% on the answer sheet for Problem 11.
Note: on a financial calculator, enter CF0=−75000, CF1=28000, CF2=32000, CF3=40000, then compute NPV (I=12) and IRR
directly.

Problem 10 Answer Problem 11 Answer

WRITE ON ANSWER SHEET:
NPV = IRR ≈ 14.9%
$3,981

Problem 12 · Chapter 9 2 pts

▶ Independent Projects with Unlimited Capital

Two independent projects: Project Delta has NPV = $9,000 (initial cost = $45,000);
Project Epsilon has NPV = $14,000 (initial cost = $65,000).
Capital is unlimited. Which project(s) should be accepted?
Write the TOTAL NPV of the accepted project(s).

FULL SOLUTION — Formula · Steps · Answer

Rule Independent projects with unlimited capital: accept ALL projects with
NPV > 0.
Each project is evaluated on its own merits; accepting one does not
 prevent accepting the other.

Step 1 Project Delta: NPV = $9,000 > 0 → ACCEPT

PI(Delta) = (45,000 + 9,000) / 45,000 = 54,000/45,000 = 1.20 > 1 ✓

Step 2 Project Epsilon: NPV = $14,000 > 0 → ACCEPT

PI(Epsilon) = (65,000 + 14,000) / 65,000 = 79,000/65,000 = 1.22 > 1 ✓

Step 3 Total NPV = $9,000 + $14,000 = $23,000

Accept BOTH projects; combined they add $23,000 to firm value.

Total NPV (both accepted)

WRITE ON ANSWER SHEET:
$23,000
 CHAPTER 8 — RISK AND RETURN Practice Problems 13–
24

Problem 13–14 · Chapter 8 2 pts

▶ Holding Period Return (HPR) & Effective Annual Rate (EAR)

You buy a stock for $40.00 per share, hold it for 2 years, sell it for $48.00, and receive annual dividends of
$1.20 per year.

Problem 13. Calculate the Holding Period Return (HPR) as a percentage.

Problem 14. Using the HPR from Problem 13, calculate the Effective Annual Rate (EAR) to two decimal places.

FULL SOLUTION — Formula · Steps · Answer

Formula HPR = (Total Income + Capital Gain) / Beginning Price

(P13) Total income = sum of all dividends received during the holding period.
Capital gain = Selling price − Purchase price.

Step 1 Total dividends = $1.20 × 2 years = $2.40

P13 Capital gain = $48.00 − $40.00 = $8.00
HPR = ($2.40 + $8.00) / $40.00 = $10.40 / $40.00 = 0.26 = 26.0%

Formula EAR = (1 + HPR)^(1/n) − 1

(P14) where n = holding period in years. EAR converts a multi-period return to an
annualised compound rate.

Step 2 EAR = (1 + 0.26)^(1/2) − 1 = (1.26)^0.5 − 1

P14 (1.26)^0.5 = √1.26 = 1.12250
EAR = 1.12250 − 1 = 0.12250 = 12.25%

ANSWER SHEET NOTE: Problem 13 asks for HPR → write 26.0% on the answer sheet for Problem 13.
Problem 14 asks for EAR → write 12.25% on the answer sheet for Problem 14.
The HPR (26%) is the intermediate result for Problem 14 — do not confuse the two.

Problem 13 — HPR Problem 14 — EAR

WRITE ON ANSWER SHEET:
26.0% 12.25%

Problem 15 · Chapter 8 2 pts

▶ Sample Standard Deviation of Returns

A stock's annual returns over 5 years are: 6%, 14%, −3%, 18%, 10%.
Calculate the SAMPLE STANDARD DEVIATION (to two decimal places).

FULL SOLUTION — Formula · Steps · Answer

Formula s = √[ Σ(R_i − R̄)² / (n − 1) ]

where R̄ = arithmetic mean of returns and n = number of observations.
 Use n − 1 (not n) in the denominator for the SAMPLE standard deviation.

Step 1 Calculate the mean (R̄):

R̄ = (6 + 14 + (−3) + 18 + 10) / 5 = 45 / 5 = 9.0%

Step 2 Calculate squared deviations:

(6 − 9)² = (−3)² = 9
(14 − 9)² = (5)² = 25
(−3 − 9)² = (−12)² = 144
(18 − 9)² = (9)² = 81
(10 − 9)² = (1)² = 1
Sum = 9 + 25 + 144 + 81 + 1 = 260

Step 3 Sample variance = 260 / (5 − 1) = 260 / 4 = 65

Sample std dev = √65 = 8.06%

Answer — Std Dev

WRITE ON ANSWER SHEET:
8.06%

Problem 16 · Chapter 8 2 pts

▶ CAPM — Expected Return (given Market Return)

The expected return on the market is 12%, the risk-free rate is 3%, and a stock has beta = 1.5.
According to CAPM, what is the expected return on the stock?

FULL SOLUTION — Formula · Steps · Answer

Formula CAPM: E(R_i) = R_f + β_i × (E(R_m) − R_f)

where: R_f = risk-free rate; β_i = beta of the stock; E(R_m) = expected
market return;
(E(R_m) − R_f) = Market Risk Premium (MRP).

Step 1 Market Risk Premium (MRP) = E(R_m) − R_f = 12% − 3% = 9.0%

Step 2 E(R) = 3% + 1.5 × 9.0% = 3% + 13.5% = 16.5%

CAPM Expected Return

WRITE ON ANSWER SHEET:
16.5%

Problem 17 · Chapter 8 2 pts

▶ Portfolio Beta

You invest $12,000 in Stock P (beta = 1.6) and $18,000 in Stock Q (beta = 0.7).
Calculate the PORTFOLIO BETA.

FULL SOLUTION — Formula · Steps · Answer

 Formula Portfolio Beta = Σ (w_i × β_i)
where w_i = dollar investment in stock i / total portfolio value.

Step 1 Total investment = $12,000 + $18,000 = $30,000

w_P = 12,000 / 30,000 = 0.40 (40%)
w_Q = 18,000 / 30,000 = 0.60 (60%)

Step 2 Portfolio β = 0.40 × 1.6 + 0.60 × 0.7

= 0.64 + 0.42 = 1.06

Portfolio Beta
WRITE ON ANSWER SHEET:
1.06

Problem 18 · Chapter 8 2 pts

▶ Portfolio Expected Return (Weighted Average)

A portfolio has 35% in Stock A (expected return 13%) and 65% in Stock B (expected return 7%).
Calculate the PORTFOLIO EXPECTED RETURN.

FULL SOLUTION — Formula · Steps · Answer

Formula E(R_p) = Σ w_i × E(R_i) = w_A × E(R_A) + w_B × E(R_B)

Step 1 E(R_p) = 0.35 × 13% + 0.65 × 7%

= 4.55% + 4.55% = 9.10%

Portfolio E(R)
WRITE ON ANSWER SHEET:
9.10%
 Problem 19–20 · Chapter 8 2 pts

▶ Portfolio Expected Return & Portfolio Standard Deviation

Stock C: E(R) = 16%, Standard deviation = 28%

Stock D: E(R) = 10%, Standard deviation = 18%
Correlation between C and D = 0.25. Portfolio weights: 50% in each.

Problem 19. Calculate the EXPECTED RETURN of the portfolio.

Problem 20. Calculate the STANDARD DEVIATION of the portfolio (to two decimal places).

FULL SOLUTION — Formula · Steps · Answer

Formula E(R_p) = w_C × E(R_C) + w_D × E(R_D)

(P19) Note: correlation does NOT affect expected return — only portfolio
variance/std dev.

Step 1 E(R_p) = 0.50 × 16% + 0.50 × 10% = 8% + 5% = 13.0%

P19

Formula Portfolio Variance:

(P20) σ²_p = w_C² × σ_C² + w_D² × σ_D² + 2 × w_C × w_D × σ_C × σ_D × ρ_CD
Portfolio Std Dev = √σ²_p

Step 2 Calculate each term:

P20 w_C² × σ_C² = (0.5)² × (0.28)² = 0.25 × 0.0784 = 0.01960
w_D² × σ_D² = (0.5)² × (0.18)² = 0.25 × 0.0324 = 0.00810
2 × w_C × w_D × σ_C × σ_D × ρ = 2 × 0.5 × 0.5 × 0.28 × 0.18 × 0.25
= 0.5 × 0.0504 × 0.25 = 0.00630

Step 3 σ²_p = 0.01960 + 0.00810 + 0.00630 = 0.03400

P20 σ_p = √0.03400 = 0.18439 = 18.44%

ANSWER SHEET NOTE: Problem 19 asks for the portfolio expected return → write 13.0% on the answer sheet for Problem
19.
Problem 20 asks for the portfolio standard deviation → write 18.44% on the answer sheet for Problem 20.
The variance (0.0340) is the intermediate result for Problem 20 — show it in your working but write the std dev (18.44%) as the
final answer.

P19 — Portfolio E(R) P20 — Portfolio Std Dev

WRITE ON ANSWER SHEET:
13.0% 18.44%

Problem 21 · Chapter 8 2 pts

▶ Standard Deviation from Variance

The variance of a stock's returns is 0.0196.

What is the standard deviation (expressed as a percentage)?

FULL SOLUTION — Formula · Steps · Answer

 Formula Standard Deviation = √(Variance)
Both variance and standard deviation must be in the same units (either
both as decimals or both as percentages).

Step 1 σ = √0.0196 = 0.14 = 14%

Verification: 0.14² = 0.0196 ✓

Standard Deviation
WRITE ON ANSWER SHEET:
14.0%

Problem 22 · Chapter 8 2 pts

▶ CAPM — Required Return (given Market Risk Premium)

A stock has beta = 1.3, the risk-free rate = 2.0%, and the market risk premium = 7.0%.
What is the required return according to CAPM?

FULL SOLUTION — Formula · Steps · Answer

Formula CAPM: E(R) = R_f + β × MRP

When the Market Risk Premium (MRP = E(R_m) − R_f) is given directly,
substitute it straight in.

Step 1 E(R) = 2.0% + 1.3 × 7.0% = 2.0% + 9.1% = 11.1%

CAPM Required Return

WRITE ON ANSWER SHEET:
11.1%
 Problem 23 · Chapter 8 2 pts

▶ Annual Percentage Rate (APR) — Simple Annualisation

You buy a bond for $990 and sell it after 8 months for $1,050. No coupon is received.
Calculate the APR (simple annual return) as a percentage to two decimal places.

FULL SOLUTION — Formula · Steps · Answer

Formula APR (simple) = (Return over period) × (12 / number of months)

This uses simple (not compound) annualisation — it scales the holding-
period return to a full year.

Step 1 Return over 8 months = (1,050 − 990) / 990 = 60 / 990 = 0.06061 =

6.061%

Step 2 APR = 6.061% × (12/8) = 6.061% × 1.5 = 9.09%

APR (simple annual)

WRITE ON ANSWER SHEET:
9.09%

Problem 24 · Chapter 8 2 pts

▶ Expected Return — Probability-Weighted Scenarios

A stock's possible returns under three economic scenarios:

Boom (probability = 0.25, return = 30%)
Normal (probability = 0.50, return = 12%)
Bust (probability = 0.25, return = −6%)
Calculate the EXPECTED RETURN (to one decimal place).

FULL SOLUTION — Formula · Steps · Answer

Formula E(R) = Σ P_i × R_i = P_Boom × R_Boom + P_Normal × R_Normal +

P_Bust × R_Bust
Check: probabilities must sum to 1.0 → 0.25 + 0.50 + 0.25 = 1.00 ✓

Step 1 E(R) = 0.25 × 30% + 0.50 × 12% + 0.25 × (−6%)

= 7.5% + 6.0% + (−1.5%)
= 12.0%

Expected Return
WRITE ON ANSWER SHEET:
12.0%
 CHAPTER 10 — CASH FLOW ESTIMATION Practice Problems 25–
36

Problem 25 · Chapter 10 2 pts

▶ MACRS Depreciation — Year 4 of a 5-Year Asset

Equipment cost = $320,000; installation cost = $30,000.

Total depreciable basis = $320,000 + $30,000 = $350,000.
MACRS 5-year class. Rates: Year 1 = 20.00%; Year 2 = 32.00%; Year 3 = 19.20%; Year 4 = 11.52%; Year 5
= 11.52%; Year 6 = 5.76%.
What is the MACRS depreciation in YEAR 4?

FULL SOLUTION — Formula · Steps · Answer

Key rule Depreciable basis = Purchase price + All costs to bring the asset to
working condition
(freight, installation, etc. are capitalised, not expensed).
MACRS depreciation_t = Depreciable basis × MACRS rate_t

Step 1 Depreciable basis = $320,000 + $30,000 = $350,000

Step 2 Year 4 MACRS rate = 11.52% = 0.1152

Year 4 Depreciation = $350,000 × 0.1152 = $40,320

Year 4 Depreciation
WRITE ON ANSWER SHEET:
$40,320

Problem 26–27 · Chapter 10 2 pts

▶ MACRS Book Value & After-Tax Salvage Value

Equipment original cost = $400,000. MACRS 5-year class.

MACRS rates: Year 1 = 20%; Year 2 = 32%; Year 3 = 19.2%; Year 4 = 11.52%; Year 5 = 11.52%; Year 6 =
5.76%.
After 3 years of MACRS depreciation, the equipment is sold for $90,000. Tax rate = 28%.

Problem 26. What is the BOOK VALUE of the equipment after 3 years?
Problem 27. What is the AFTER-TAX SALVAGE VALUE?

FULL SOLUTION — Formula · Steps · Answer

Formula Book value = Original cost − Accumulated MACRS depreciation

After-tax salvage = Selling price − Tax × (Selling price − Book value)
If Selling price < Book value → loss → tax SAVING (add back to selling price)
If Selling price > Book value → gain → tax PAYMENT (deduct from selling
price)
 Step 1 MACRS depreciation for Years 1–3:
P26 Year 1: $400,000 × 20.00% = $80,000
Year 2: $400,000 × 32.00% = $128,000
Year 3: $400,000 × 19.20% = $76,800
Accumulated depreciation = 80,000 + 128,000 + 76,800 = $284,800

Step 2 Book value (P26) = $400,000 − $284,800 = $115,200

P26

Step 3 Compare selling price vs. book value:

P27 Selling price = $90,000; Book value = $115,200
Selling price < Book value → LOSS = $90,000 − $115,200 = −$25,200
→ This loss generates a TAX SAVING = $25,200 × 28% = $7,056

Step 4 After-tax salvage value = Selling price + Tax saving

P27 = $90,000 + $7,056 = $97,056

ANSWER SHEET NOTE: Problem 26 asks for the book value after 3 years → write $115,200 on the answer sheet for
Problem 26.
Problem 27 asks for the after-tax salvage value → write $97,056 on the answer sheet for Problem 27.
Both answers come from the same asset data. The book value ($115,200) is also an intermediate step for Problem 27.

P26 — Book Value P27 — After-Tax Salvage

WRITE ON ANSWER SHEET:
$115,200 $97,056

Problem 28 · Chapter 10 2 pts

▶ Erosion Cost (Cannibalization)

A new product causes existing product sales to fall from 70,000 units to 55,000 units per year.
Contribution margin per unit on the existing product = $10.00.
Calculate the ANNUAL EROSION COST.

FULL SOLUTION — Formula · Steps · Answer

Concept Erosion (cannibalization) cost = Lost units × Contribution margin per

unit
This is a negative incremental cash flow — the firm loses this contribution
margin because the new product steals sales from the existing product.

Step 1 Lost units = 70,000 − 55,000 = 15,000 units per year

Step 2 Annual erosion cost = 15,000 × $10.00 = $150,000 per year

This $150,000 is an INCREMENTAL CASH OUTFLOW in the new
project's cash flow model.

Annual Erosion Cost

WRITE ON ANSWER SHEET:
$150,000
 Problem 29 · Chapter 10 2 pts

▶ Present Value of Net Working Capital Cash Flows

A project requires an initial net working capital (NWC) increase of $50,000 at Year 0,
which is fully recovered at the end of 5 years. Discount rate = 9%.
What is the PRESENT VALUE of the combined NWC cash flows (outflow and inflow)?

FULL SOLUTION — Formula · Steps · Answer

Concept NWC timing:

Year 0: NWC invested → cash OUTFLOW of $50,000 (PV = −$50,000, no
discounting needed).
Year 5: NWC recovered → cash INFLOW of $50,000 discounted back to
Year 0.

Step 1 PV(recovery) = $50,000 / (1.09)^5

(1.09)^5 = 1.53862
PV(recovery) = $50,000 / 1.53862 = $32,497.24

Step 2 Net PV of NWC flows = −$50,000 + $32,497.24 = −$17,502.76

The negative sign confirms a net cost — the time value of money
means recovery at Year 5
is worth less than the initial outlay at Year 0.

Net PV of NWC Flows

WRITE ON ANSWER SHEET:
−$17,502.76

Problem 30 · Chapter 10 2 pts

▶ Annual Depreciation Tax Shield (Straight-Line)

Equipment cost = $600,000; useful life = 8 years (straight-line); salvage value = $60,000.
Tax rate = 30%.
Calculate the ANNUAL DEPRECIATION TAX SHIELD.

FULL SOLUTION — Formula · Steps · Answer

Formula Annual Straight-Line Depreciation = (Cost − Salvage) / Life

Annual Tax Shield = Depreciation × Tax rate
The tax shield is the cash benefit from depreciation reducing taxable
income.

Step 1 Annual depreciation = ($600,000 − $60,000) / 8 = $540,000 / 8 = $67,500

Step 2 Annual tax shield = $67,500 × 0.30 = $20,250

Annual Depreciation Tax Shield

WRITE ON ANSWER SHEET:
$20,250
 Problem 31 · Chapter 10 2 pts

▶ Operating Cash Flow (OCF) — Standard Formula

A project has: EBIT = $180,000; Taxes = $45,000; Depreciation = $65,000.

Calculate the OPERATING CASH FLOW (OCF).

FULL SOLUTION — Formula · Steps · Answer

Formula OCF = EBIT − Taxes + Depreciation

This is equivalent to: OCF = Net Income + Depreciation (bottom-up
approach).
Depreciation is added back because it is a non-cash expense — it reduced
EBIT but required no cash outlay.

Step 1 OCF = $180,000 − $45,000 + $65,000 = $200,000

Operating Cash Flow

WRITE ON ANSWER SHEET:
$200,000

Problem 32 · Chapter 10 2 pts

▶ After-Tax Salvage Value (Original Cost + Accumulated Depreciation Given)

Equipment is sold for $55,000.

Original cost = $160,000. Accumulated depreciation = $120,000. Tax rate = 30%.
Calculate the AFTER-TAX SALVAGE VALUE.

FULL SOLUTION — Formula · Steps · Answer

Formula Book value = Original cost − Accumulated depreciation

After-tax salvage = Selling price − Tax × (Selling price − Book value)
If gain (sell > book): pay tax on gain. If loss (sell < book): receive tax
saving.

Step 1 Book value = $160,000 − $120,000 = $40,000

Step 2 Gain = $55,000 − $40,000 = $15,000 (selling price ABOVE book →

taxable gain)

Step 3 Tax on gain = $15,000 × 0.30 = $4,500

Step 4 After-tax salvage = $55,000 − $4,500 = $50,500

After-Tax Salvage Value

WRITE ON ANSWER SHEET:
$50,500
 Problem 33 · Chapter 10 2 pts

▶ Total Terminal-Year Cash Flow

Project summary:
Year 0: Capital expenditure = $1,500,000; NWC increase = $100,000.
Year 5: OCF = $400,000; NWC recovery = $100,000; after-tax salvage value = $200,000.
What is the TOTAL CASH FLOW in Year 5?

FULL SOLUTION — Formula · Steps · Answer

Concept Year 5 total CF = OCF + NWC Recovery + After-Tax Salvage

Terminal year cash flows combine three components:
(1) Operating Cash Flow from the year's operations.
(2) Recovery of NWC invested at Year 0 (now returned as a cash inflow).
(3) After-tax proceeds from selling the asset.

Step 1 Total Year 5 CF = $400,000 + $100,000 + $200,000 = $700,000

Year 5 Total Cash Flow

WRITE ON ANSWER SHEET:
$700,000

Problem 34 · Chapter 10 2 pts

▶ Operating Cash Flow — Tax Shield Approach

Project data: Sales revenue = $700,000; Cash operating costs = $280,000;

Depreciation = $90,000; Tax rate = 28%.
Calculate OCF using the TAX SHIELD APPROACH.

FULL SOLUTION — Formula · Steps · Answer

Formula OCF = (Sales − Cash Costs) × (1 − T) + Depreciation × T

First term = after-tax cash profit (excluding depreciation).
Second term = depreciation tax shield (the tax saving from the non-cash
deduction).

Step 1 (Sales − Cash Costs) = $700,000 − $280,000 = $420,000

Step 2 After-tax cash profit = $420,000 × (1 − 0.28) = $420,000 × 0.72 =

$302,400

Step 3 Depreciation tax shield = $90,000 × 0.28 = $25,200

Step 4 OCF = $302,400 + $25,200 = $327,600

Cross-check (standard formula): EBIT = 420,000−90,000 = 330,000; Tax
= 330,000×0.28 = 92,400;
OCF = 330,000 − 92,400 + 90,000 = $327,600 ✓

OCF (Tax Shield Approach)

WRITE ON ANSWER SHEET:
$327,600
 Problem 35 · Chapter 10 2 pts

▶ MACRS Depreciation — Year 2 of a 7-Year Asset

Machine cost = $520,000; installation = $30,000. Total basis = $550,000.

MACRS 7-year class. Rates: Year 1=14.29%; Year 2=24.49%; Year 3=17.49%; Year 4=12.49%; ...
What is the depreciation in YEAR 2?

FULL SOLUTION — Formula · Steps · Answer

Step 1 Depreciable basis = $520,000 + $30,000 = $550,000

Step 2 Year 2 MACRS rate = 24.49% = 0.2449

Year 2 Depreciation = $550,000 × 0.2449 = $134,695

Year 2 Depreciation (7-yr MACRS)

WRITE ON ANSWER SHEET:
$134,695

Problem 36 · Chapter 10 2 pts

▶ After-Tax Cash Flow from Selling the Old Machine (Replacement Project)

A replacement project requires selling the old machine today.

Old machine: book value = $100,000; can be sold today for $70,000. Tax rate = 35%.
Calculate the AFTER-TAX CASH FLOW from selling the old machine at Year 0
(this is a cash INFLOW that reduces the net initial investment).

FULL SOLUTION — Formula · Steps · Answer

Concept In a replacement project, selling the old machine provides a cash

inflow at Year 0.
If the sale price differs from book value, there is a tax gain or loss.
Formula: After-tax CF = Sale price − Tax × (Sale price − Book value)

Step 1 Compare: Sale price ($70,000) < Book value ($100,000) → LOSS on
sale
Loss = $70,000 − $100,000 = −$30,000

Step 2 Tax saving = $30,000 × 0.35 = $10,500

(The loss reduces taxable income → the firm effectively saves $10,500
in taxes)

Step 3 After-tax CF = Sale price + Tax saving = $70,000 + $10,500 = $80,500

This $80,500 is treated as a CASH INFLOW at Year 0 in the net initial
investment calculation.

After-Tax CF from Old Machine Sale

WRITE ON ANSWER SHEET:
$80,500 (inflow)