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%
Project A
Project B
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)
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% |
|
|
Project A |
Project B |
||
|
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)
Related questions
You are a financial analyst for the Waffle Company. The director of capital budgeting has asked you to analyze two proposed capital investments, Projects A and B. Each project has a cost of $50,000, and the cost of capital for each is 10%.
The projects’ expected net cash flows are as follows:
|
|
Expected Net Cash Flows |
|
|
Year |
Project A |
Project B |
|
0 |
($50,000) |
($50,000) |
|
1 |
25,000 |
15,000 |
|
2 |
20,000 |
15,000 |
|
3 |
10,000 |
15,000 |
|
4 |
5,000 |
15,000 |
|
5 |
5,000 |
15,000 |
- Calculate each project’s payback period, net present value (NPV), internal rate of return (IRR), modified internal rate of return (MIRR), and profitability index (PI).
Mr Yaqoob is a financial analyst for M/s Sheeraz & Co. The director of capital budgeting has asked Yaqoob to analyze two proposed capital investments, Projects X and Y. Each project has a cost of Rs. 5,000, and the cost of capital for each project is 10 percent. The projects’ expected net cash flows are as follows:
|
|
Expected Net Cash Flows |
|
|
Year |
Project X |
Project Y |
|
0 |
Rs. (5000) |
Rs. (5000) |
|
1 |
3250 |
1750 |
|
2 |
1500 |
1750 |
|
3 |
1500 |
1750 |
|
4 |
500 |
1750 |
- Calculate each project’s payback period, net present value (NPV), and internal rate of return (IRR). [3]
- Which project or projects should be accepted if they are independent? [0.5]
- Which project should be accepted if they are mutually exclusive? [0.5]
d. How might a change in the cost of capital produces a conflict between the NPV and IRR rankings of these two projects?
| Question: | ||||
| The Sanders Electric Company is evaluating two projects for possible inclusion in the firmâs capital budget. Project M will require a $37,000 investment while project Oâs investment will be $46,000. After-tax cash inflows are estimated as follows for the two projects: | ||||
| Year | Project M | Project O | ||
| 1 | $12,000 | $10,000 | ||
| 2 | 12000 | 10000 | ||
| 3 | 12000 | 15000 | ||
| 4 | 12000 | 15000 | ||
| 5 | 15000 | |||
| a. | Determine the payback period for each project. | |||
| Payback (M) = | ||||
| Payback (O) = | ||||
| b. | Calculate the net present value and profitability index for each project based on a 10 percent cost of capital. Which, if either, of the project is acceptable? | |||
| NPV (M) = | ||||
| PI (M) = | ||||
| NPV (O) = | ||||
| PI (O) = | ||||
| c. | Determine the internal rate of return and modified internal rate of return for Projects M and O. | |||
| IRR (M): | ||||
| IRR (O): | ||||
| MIRR calculation of project M: | ||||
| MIRR calculation of project O: | ||||
