Capital Bugeting (Solved) Essay

1816 words - 8 pages

Capital Budgeting
(Practice Problem Solutions)

Q1. Evaluation of Cash Flows.

Below are the cash flows for two mutually exclusive projects.

Year CFX CFY
0 (5,000) (5,000)
1 2,085 0
2 2,085 0
3 2,085 0
4 2,085 9,677

a. Calculate the payback for both projects.
b. Initially, the cost of capital is uncertain, so construct NPV profiles for the two projects (on the same graph) to assist in the analysis. The profiles cross at what cost of capital? What is the significance of that?
c. It is now determined that the cost of capital for both projects is 14%. Which project should be selected? Why?
d. Calculate the MIRR for both ...view middle of the document...

51) years
= 3.51 years

B)

NPV profile for two projects with different cash flows pattern
[pic]

|Rate |Project X (NPV) |Project Y (NPV) |
|@0% = |3340 |4677 |
|@5% = |2393.31 |2961.29 |
|@10% = |1609.17 |1609.52 |
|@15% = |952.63 |532.86 |
|@20% = |397.51 |-333.24 |
|@25% = |-76.06 |-1036.30 |
|@30% = |-483.39 |-1611.81 |

Crossover:
The NPV profile of two mutually exclusive projects crossover at 10%, which means that if the required rate of return is less than 10%, the company should invest in project Y as it has greater NPV then project X but if the required rate of return is more than 10%, the company should invest in project X as it has greater NPV than project Y.

C)
Project X= NPV@14%= 1075.09
Project Y= NPV@14%= 729.56

Project X should be selected at 14% cost of capital because of higher NPV.

D)

Project X

[pic]

MIRR = 4√10260.59/5000 -1
= 1.1968 -1
= 0.1968 OR 19.68%

Project Y

[pic]

= 4√9677/5000 -1
= 1.1794 -1
= 0.1794 OR 17.94%

Q2. More practice with Cash Flow Evaluation.

Cash flows for two mutually exclusive projects are shown below:

Year CFM CFN
0 (100) (100)
1 10 70
2 60 50
3 80 20

Both projects have a cost of capital of 10%.

a. Calculate the payback for both projects.
b. Calculate the NPV for both projects.
c. Calculate the IRR for both projects.
d. Calculate the MIRR for both projects.

Solution:

A)

Project M

|Year |0 |1 |2 |3 |
|Cash Flows |-100 |10 |60 |80 |
|Cumulative Cash |-100 |-90 |-30 |50 |
|flows | | | | |

Payback Period= (2+30/80) Years
= (2+0.37) Years
= 2.37 Years

Project N

|Year |0 |1 |2 |3 |
|Cash Flows |-100 |70 |50 |20 |
|Cumulative Cash |-100 |-30 |20 |40 |
|flows | | | | |

Payback Period=...

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