🧭 PS 3 Question Interpretation

I thought it might be helpful to put into writing some details on how to interpret the problem set questions. The grading rubric on the assignments in this course generally only allows for one interpretation of the questions. If you interpret them differently, then the computer will mark your answer as wrong.

While I can’t generally override the question rubric, I’m always happy to clarify questions before you submit the assignment. This is why I strongly suggest that you review the following document before submitting your assignment. Most of the interpretations will likely come across as common sense, but you might pick up a point or two!

You may find it helpful to review our “MyFinanceLab Dos and Donts - 2700.docx” file on the homepage of Canvas (you’ll have to scroll down). The most important advice in the page is to reread the question with your answer in place. Does it say what you want it to say in normal American english?

If a number is negative, generally use a minus sign, not parentheses. If you are entering numbers into a pro-forma or incremental financial statement, you can use parentheses, but if you try to enter parentheses into a fill-in-the-blank question, the parentheses will turn red to indicate that you are supposed to use regular English usage (ie a minus sign).

I did some experiments. For several questions, I entered numbers both with separator commas and without (ie 12,345,678 vs 12345678) and I got full credit either way. For financial statements, I got full credit both when I used parentheses and minus signs (ie -123 vs (123)). However, I encourage people to use minus signs because you can never go wrong using a minus sign to indicate a negative number in this course.

Question 1

The question asks for the same number in two different ways.

• What is the most you can pay and still have a positive NPV? (Assuming a discount factor of 12%.)
• What is the most you can pay and still achieve a return of 12%.

These two ways of asking the question are equivalent. If you have an NPV of 0 using a discount factor of 12%, it means that your return (ie your IRR) is 12% [before taking into account the cost of capital].

This follows from the definition of IRR (and IRR is what we mean by return). By definition, the IRR is the discount rate where the NPV =0. Therefore, when a question asks you for “breakeven” NPV and specificies a discount rate, that

Question 5

• Note that the question asks for “yearly” depreciation expense.
• As in class, “Transportation and installation” is considered capital expenditure and is treated as such.
• It says “Round to the nearest dollar,” so enter your answer in dollars. It already includes a dollar sign, so don’t enter a dollar sign. In general, when it asks for a number in a fill in the blank question, only enter a number.

Question 6

• See advice above.
• Use the straight-line approach to handle the depreciation.
• It mentions that the machine will generate incremental expenses. These expenses are generated by the operation of the machine and don’t include depreciation (which is essentially prorated capital expenditure).

Question 7

• Incremental always refers to the change in something. It doesn’t include the original amount.

Question 8

Question 9

The question asks you to enter a single number that is the cash flow for years 1-5. From this, you may conclude that the free cash flow in year 1, 2, 3, 4, and 5 are all equal:

In other words,

$$FCFYear1 = FCFYear2 = FCFYear3 = FCFYear4 = FCFYear5$$

Free Cash Flow is generally an annual number (or, more generally ‘per reporting period,’ but we don’t get into those weeds). Therefore, if free cash flow is 1M in each of the first five years, when it asks the following, enter 1000000, not 5000000:

Don’t forget that, as Bruce mentioned during lecture, you should treat the installation and transportation expense as a form of capital expenditure. This is because installing a machine is part of its expense.

Question 10

As indicated by the question, all numbers should be entered in millions.

When entering, follow the convention that Bruce used in the slides. I would call this the “write numbers so you can add it up” convention.

Question 11

• Because the prompt is “The free cash flow is ​$___ million (Round to one decimal​ place.)“
  • enter only a number with one decimal place
  • the number should be the number of millions of dollars of FCF.

Question 12

The money spent promoting the candy occurs at the start, well before the second year of the project. Therefore, it does not affect the second year’s financials.

Question 13

Choose the closest answer for question 10. Your answer should be within $20000 of the option you choose.

Each year, change in NWC requirements was -$12K (ie needs decreased by $12K) Perhaps this project implemented a “just in time” inventory program, such that each year, the inventory you must keep in your warehouses decreases by $12,000. The bottom line is that NWC needs decrease by $12K each year.

As always, don’t worry about if the total depreciation doesn’t equal the capex. Just plug the numbers in as they are. (It’s not bad to ask, though, because I can confirm you aren’t missing anything.)

Purchased $600K of capital.

Depreciation expense each year of 180K.

Each year, change in NWC requirements was -$12K (ie needs decreased by $12K).

Question 14

There are some inconsistencies with the numbers in the table, but you don’t need to worry about these. To solve this question, just take the incremental earnings as given in the bottom line of the table and apply the process that Bruce uses in Example 9.4a. (This is also the process that I use during sections because it is the way with the most intuition.)

Question 15

”Initially” means T=0, so the Capex to set up the project happens at T=0. It says that Revenues are “paid in one year.” This means T=1. The expenses will also occur at T=1.

Use whatever numbers you are given in this question. If the total depreciation in your question is not equal to the cost of the good, assume that there is a good reason for this (perhaps it needs to be written off).

DO NOT assume that THSI gets any tax benefit from the losses at the start of the program. The accounting rules required to analyze that are saved for a separate course. This course is completely self-contained.