FIN 401 Lecture Notes - Lecture 7: Discount Window, Net Present Value, Capital Budgeting

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8 Jan 2018

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Pv2nd= 8/0. 08 x 1/ (1+0. 08) ^5 = . 06price today= Net present value: the diff. between value and cost of a project in present value terms. (a positive npv means project is to add value to firm, goal of f. m) Internal rate of return (irr): what is the rate of return that makes. Accept if irr is greater than required rate of return. (tvm, i=same, irr=?) *always use npv because it directly measures the increases in firm value. Crossover rate: the discount rate at which the npvs of two projects are equal. Profitability index: measures the benefit per unit cost, based on. Pi= pv (cash inflows)/ pv (cash outflows) a p. i of 1. 1 implies for every invest, we create an additional sh. 10 in firm value. Relevant/incremental cash flows: cash flows that should be included in a capital budgeting analysis are those that will only occur (or not occur) if a project is acc.

Related Questions

Q6) Assume yourself as a financial analyst for the Great Land Company. Then, the director of capital budgeting asks you to analyse two proposed capital investments named Project A and Project B. Each project has a cost of 900,000 birr, and the cost of capital (the required rate of return) for each project is 10%. The information on the projects’ expected net cash flows are as follows with the present value of 1 birr at 10%.

Year	Cash flow of the projects in Birr		PV of 1birr at 10%
Year	Project A	Project B	PV of 1birr at 10%
0	- 900,000	- 900,000	1
1	400,000	245,000	0.909
2	350,000	245,000	0.826
3	250,000	245,000	0.751
4	150,000	245,000	0.683
5	100,000	245,000	0.621

Required:

Calculate each project’s payback period (PBP) and determine which project is preferable as per PBP results. (2 pts)
Calculate each project’s net present value (NPV). (2 Pts)
Determine and justify which project or projects should be accepted as per NPV results if they are independent projects. (2Pts).
Determine and justify which project or projects should be accepted as per NPV if they are mutually exclusive projects. (2Pts).
Calculate the internal rate of return (IRR) for each project and determine whether the projects are accepted or rejected as per IRR result and also determine which project is preferable based on IRR. (2Pts)
Discuss the relative strengths and limitations of the capital budgeting decision criteria that you have used above (Payback period, NPV and IRR).( 3Pts)

goldcoyote821

Calculating Payback. Global Toys Inc., imposes a payback cutoff of three years for its international investment projects. If the company has the following two projects available, should it accept either of them?

Year Cash Flow (A) Cash Flow (B)
0 â$55,000 â$ 95,000
1 19,000 18,000
2 27,000 26,000
3 24,000 28,000
4 9,000 260,000

Which Project should be accepted A or B?

a. The payback for Project A is: Payback =

b. The payback for Project B is: Payback =

c. Which project should be accepted:

____________________________________
Calculating AAR. Youâre trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $14 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $1,253,000, $1,935,000, $1,738,000, and $1,310,000 over these four years, what is the projectâs average accounting return (AAR)?

Calculating AAR, the average net income divided by the average book value. (Show work by calculating net income and average book value):

a. Average net income =

b. Average book value =

c. AAR =

_________________________________________

Calculating IRR. A firm evaluates all of its projects by applying the IRR rule. If the required return is 11 percent, should the firm accept the following project?

Year Cash Flow
0 â$153,000
1 78,000
2 67,000
3 49,000

Calculating IRR the interest rate that makes the NPV of the project equal to zero. (Show work by calculating IRR):

a. IRR =

b. Should the project be accepted and why?

________________________________

Calculating NPV. For the cash flows in the previous problem, suppose the firm uses the NPV decision rule. At a required return of 9 percent, should the firm accept this project? What if the required return was 21 percent?

Calculating NPV. Hint the NPV of a project is the PV of the outflows minus by the PV of the inflows. (Show work by calculating NPV):

a. @ 9% required return.

NPV@ 9% required return =

b. Should the project be accepted:

c. @ 21% required return.

NPV@ 21% required return =

d. Should the project be accepted:

orangecricket262

Problem 1

All Techniques- Decision among mutually exclusive investments. Pound industries is attempting to select the best of three mutually exclusive projects. The initial investment and after tax cash inflows associated with these projects are shown in the following table

Cash flow Project A Project B Project C

Initial investment (CF) $80,000 $110,000 $110,000

Cash inflows (CF), T=1 to 5 $25,000 $37,000 $38,500

Calculate the payback period for each project

Calculate the net present value (NPV) of each project, assuming that the fimrm has a cost of capital equal to 11%

Calculate the internal rate of return (IRR) for each project

Indicate which project you would recommend

A-the payback period of project A is ___years

the payback period of project B is ___years

the payback period of project C is ___years

B-the NPV of project A is $____

the NPV of project B is $____

the NPV of project C is $____

C- The IRR of project A is _____

The IRR of project B is _____

The IRR of project C is _____

D- which project would you recommend?

Project A

Project B

Project C

Problem 2

IRR, investment life, and cash inflows Oak enterprise accepts projects earning more than the firms 15% cost of capital. Oak is currently considering a 10 year project that provides annual cash inflows of $50,000 and requires an initial investment of $328,300

Deter the IRR of the project is it acceptable

Assuming that the cash inflos continue to be $50,000 per year how many additional years would the flows have to continue to make the project acceptable (that is, to make it have an IRR of 15%?

A. the project IRR is ___%

Is the project acceptable?

Yes or no

B. assuming that the cash inflows continue to be $50,000 per year the number of additional years the flows would have to continue to make the project acceptable at the 15% discount rate is ____ additional years

C) with the given life, initial investment and cost of capital the minimum annual cash inflow that the firm should accept is $______

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FIN 401 Lecture Notes - Lecture 7: Discount Window, Net Present Value, Capital Budgeting

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