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7 Jan 2018

Project C requires a net investment of $1,000,000 and has a payback period of 5.6 years. You analyze Project C and decide that Year 1 free cash flow is $100,000 too low, and Year 3 free cash flow is $100,000 too high. After making the necessary adjustments ________. Answer A)the NPV of Project C will decrease B)the payback period for Project C will be shorter than 5.6 years C)the IRR of Project C will increase D0the payback period for Project C will be longer than 5.6 years

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Jean Keeling
Jean KeelingLv2
9 Jan 2018

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17. You have conducted a capital budgeting analysis of projects A, B and C with the following results: NPV IRR Payback A 200,000 8.7% 4 years B -100,000 5.6% 3 years C 300,000 9.8% 5 years If r=7% and the company has set the payback cutoff at 3 years, which is false? (a) Each project is acceptable under at least one method (b) The IRR and NPV would lead to different acceptance decisions on at least one project (c) The payback period focuses on speed of payback instead of the best financial decision (d) Based on best practices for capital budgeting discussed in class, A and C should be accepted

why A is true and B is false??

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 $______

QUESTION 6 [Total 29 marks]

A listed company has a proposed investment project where the expected cash flows are given in the table below. Market research into a feasibility study for the project was conducted at a cost of $5,000. The risk-free rate of return is given as 2% per annum. The yearly return for the Australian share market is given as 12%. Suppose the company has a beta value of 0.8.

Year 0 Project cash flow $(20,000)

Year 1 Project cash flow $(10,000)

Year 2 Project cash flow $(20,000)

Year 3 Project cash flow $(10,000)

Year 4 Project cash flow $(40,000)

Year 5 Project cash flow $(30,000)

(a) Determine the project’s discount rate. (4 marks)

(b) Explain what is meant by sunk costs in capital budgeting. State the amount of any sunk costs for the project. (2 marks)

(c) What type of risk does the beta value measure? Explain what is meant by this particular type of risk. (2 marks)

(d) If the maximum acceptable payback period for the project is 3 years, would the project be accepted? What are the disadvantages of the payback period method in making investment decisions? (5 marks)

(e) Explain the difference between the discounted payback period method and the payback period method. Would the project be accepted if the discounted payback period is used instead of the payback period? (5 marks) 5

(f) Explain whether the project would be accepted using the net present value (NPV) acceptance criterion. Explain why the NPV method is considered to be the best method in capital budgeting. (5 marks)

(g) Explain whether the project would be accepted using the profitability index (PI) acceptance criterion. (3 marks)

(h) Explain whether the project would be accepted using the internal rate of return (IRR) acceptance criterion. Explain why the IRR method is widely used in capital budgeting. (3 marks)

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