Capital Bugeting (Solved)

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 projects, using the 14% cost of capital.

Solution:

A)

Project X

|Year |0 |1 |2 |3 |4 |

|Cash Flows |-5000 |2085 |2085 |2085 |2085 |

|Cumulative Cash |-5000 |-2915 |-830 |1255 |3340 |

|flows | | | | | |

Payback Period = (2+830/2085) years

= (2+0.39) years

= 2.39 years

Project Y

|Year |0 |1 |2 |3 |4 |

|Cash Flows |-5000 |0 |0 |0 |9677 |

|Cumulative Cash |-5000 |-5000 |-5000 |-5000 |4677 |

|flows | | | | | |

Payback Period =...