Managerial Finance

Chapter I 0 The Basics of Capital Budgeting: Evaluating Cash Fiows

Expected Net Cash Flows Project X Project Y

0

1

2

3

4

+10,000 6,500

3,000

3,000

1,000

*$10,000

3,500

3,500

3,500

3,500

a. 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).

b. Which project or projects should be accepted if they are independent? c. Which project should be accepted if they are mutuality exclusive? d. Horv insight a change in the cost of capital produce a conflict between the NPV and

IRR rankings of these two projects? Would this conflict exist if r were 5%? (Hint: Plot the NPV profiles.)

e. Why does the conflict exist?

(10-1)

NPV

(10-2)

IRR

(10-3)

MIRR

(10-4)

Profitability Index

(10-s)

Payback

(10-6)

Discounted Payback

$o-7) NPV

A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7 years, and a cost of capital of l1o/o. What is the project’s NPV? (Hirf: Begin by constructing a time line.)

Refer to Problem l0-1. What is the project’s IRR?

Refer to Problem l0-1. What is the project’s MIRR?

Refer to Problem 10-1. What is the project’s PI?

Refer to Problem l0-1. What is the project’s payback period?

Refer to Problem 10-1. What is the project’s discounted payback period?

Your division is considering row investment projects, each of which requires an up-front expenditure of $15 million. You estimate that the investments will produce the following net cash flows:

Project B Year Project A

1

2

a

What are the two projects’ net 10o/o?. lio/a?

What are the two projects’ IRRs

present values, assuming the cost of capital is 5o/o?

at these same costs of capital?

$ 5,000,000

10,000,000

20,000,000

$20,000,000

10,000,000

6,000,000

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