“Caledonia” Products Integrative Problem

“Caledonia” Products Integrative Problem

Introduction:

12 a. What is each project’s payback period?

The payback period is the length of time required to recover the cost of an investment (Payback, 2010). To analyze the payback period for each project for Caledonia one will need to divide the cost of project by the annual cash inflow. For Project A, one would make the following calculations to receive the payback period.

$100,000 / $32,000 = 3.125 years

For Project B, the payback period would be five years. It's not until the cash inflow of $200,000 in year five that the project recovers its original cost

12 b. What is each project’s net present value?

NPV is used in capital budgeting to analyze the profitability of an investment or project.

where FCFt = the annual free cash flow in time period t (this can take on either positive or negative values)

k = the appropriate discount rate; that is, the required rate of return or cost of capital1

IO = the initial cash outlay

n = the project’s expected life

YEAR PROJECT A PROJECT B

0 –$100,000 –$100,000

1 32,000 0

2 32,000 0

3 32,000 0

4 32,000 0

5 32,000 $200,000

Required rate of return 11% 11%

Net Present Value $ 118,268.70 $ 118,690.27

12 c. What is each project’s internal rate of return?

Internal rate of return is the discount rate used to make the net present value of all cash flows equal to zero in a particular project (Internal, 2010). For Project A, one would make the following calculation to receive the internal rate of return.

-100 + 32/(1+r) + 32/(1+r)² + 32/(1+r)³ + 32/(1+r)^4 + 32/(1+r)^5 = 0

Internal rate of return ≈ 18.03%

For Project B, one would make the following calculation to receive the internal rate of return.

-100 + 0/(1+r) + 0/(1+r)² + 0/(1+r)³ + 0/(1+r)^4 + 200/(1+r)^5 = 0

Internal rate of return ≈ 14.87%

12d. What has caused the ranking conflict?

There was a ranking conflict due to...