Capital Budgeting Practice Problems

Capital budgeting practice problems.

1. 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. It is now determined that the cost of capital for both projects is 14%. Which

project should be selected? Why?

2. 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.

3. Mutually Exclusive Projects with Unequal Lives. Murray’s Coffee House is trying

to choose between two new coffee bean roasters. The required rate of return for either

machine is 10%. Shown below are the after-tax cash flows associated with each

machine:

year CFX CFY

0 (50,000) (30,000)

1 20,000 20,000

2 20,000 20,000

3 20,000

4 20,000

a. Calculate the replacement chain NPV for each project.

b. Calculate the equivalent annual annuity for each project.

c. Which project should be selected? Why?

4. Risk Adjustment and Project Selection. Acme Mfg is considering two projects, A &

B, with cash flows as shown below:

period CFA CFB

0 -50,000 -100,000

1 20,000 60,000

2 20,000 25,000

3 20,000 25,000

4 20,000 25,000

The opportunity cost of capital for A is 14 percent. The opportunity cost of capital for B is

10 percent.

a. Calculate the NPV for each project.

b. Calculate the IRR for each project.

c. Which project(s) should be accepted in each of the following situations?

(1) The projects are mutually exclusive and there is no capital constraint.

(2) The projects are independent and there is no capital constraint.

(3) The projects are independent and there is a total of $100,000 of financing for

capital outlays in the coming period.