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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. 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.

Answers: a. 2.4 yrs, 4 yrs; b. 10%; c. X; d. MIRRX = 19.69%

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.

d. Calculate the MIRR for both projects.

Answers: a. 2.4 yrs, 1.6 yrs; b. $18.78, $19.98; c. 18.1%, 23.56%; d. 16.5%, 16.9%;

3. Expansion Project. A machine has a cost of $180. It will have a life of 3 years, and will be depreciated straight line to zero salvage value. It will result in sales revenue of $200 per year and cash operating costs of $110 per year. Use of the machine will require an increase in working capital of $70 for the 3 years, beginning at year 0. The appropriate discount rate is 8% and the firm’s tax rate is 40%.

a. Calculate the initial cash flow at time 0.

b. Calculate the annual operating cash flows (they are identical each year).

c. Calculate the relevant terminal cash flows at the end of year 3.

d. What is the NPV for the machine?

Answers: a. -250; b. 78; c. 70; d. $6.58...