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(10?10) Capital Budgeting Methods

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Question;Capital Budeting Methods(10?10) Capital Budgeting Methods;Project S has a cost of $10,000 and is expected to produce benefits (cash flows) of $3,000 per year for 5 years. Project L costs $25,000 and is expected to produce cash flows of $7,400 per year for 5 years. Calculate the two projects' NPVs, IRRs, MIRRs, and PIs, assuming a cost of capital of 12%. Which project would be selected, assuming they are mutually exclusive, using each ranking method? Which should actually be selected?;Inputsr12%Initial CostTimeProject SProject L0-$10,000-$25,000Project SNPVIRRMIRRPI$814.3315.24%13.77%1.081Cash Flows1$3,000$7,4002$3,000$7,4003$3,000$7,4004$3,000$7,400Project L$1,675.3414.67%13.46%1.0675$3,000$7,400Initial CostYearProj S012345-100002678.571428572391.581632652135.340743441906.554235211702.28056716Proj L-250006607.14295899.23475267.17384702.83384198.9587Which Project is to be selected?Using NPV, Project S wins with 814.33 vs 1,675.34Using IRR, Project S also wins with 15.24% vs 14.67%Using MIRR, Project S also wins with 13.77% vs 13.46%Using PI, again, project S wins with 1.081 vs 1.067Overall, although project L has an NPV higher than project S, in both IRR and MIRR, S is higher. PI is also smaller for project S, so I would choose S over L(10?17) Unequal LivesThe Perez Company has the opportunity to invest in one of two mutually exclusivemachines that will produce a product it will need for the foreseeable future. MachineA costs $10 million but realizes after -tax inflows of $4 million per year for 4 years.After 4 years, the machine must be replaced. Machine B costs $15 million andrealizes after-tax inflows of $3.5 million per year for 8 years, after which it must bereplaced. Assume that machine prices are not expected to rise because inflation willbe offset by cheaper components used in the machines. The cost of capital is 10%. Byhow much would the value of the company increase if it accepted the better machine?What is the equivalent annual annuity for each machine?Unequal LivesInputsr10%Initial CostTimeMachine A-1Machine A-2Sum CFs0NPVA-1EFFAMachine BNPVEFFBAnalysisCash Flows1234NPVA-1,A-25678Multiple Rates of ReturnCOC8%Initial CostTimeProjectPVNPVIRRCash Flows02$4.40$0-$4a. Plot the project's NPV profile.b. Should the project be accepted if r = 8%? If r = 14%? Explain your reasoning.aData table for questionCost of Capital NPVIRR-$4.40c. Can you think of some other capital budgeting situations in which negative cashflows during or at the end of the project's life might lead to multiple IRRs?0%d. What is the project's MIRR at r = 8%? At r = 14%? Does the MIRR method lead tothe same accept-reject decision as the NPV met2%4%6%8%10%12%14%16%18 %100 0%400%b1(10?19) Multiple Rates of ReturnThe Ulmer Uranium Company is deciding whether or not it should open a strip minewhose net cost is $4.4 million. Net cash inflows are expected to be $27.7 million, allcoming at the end of Year 1. The land must be returned to its natural state at a cost of$25 million, payable at the end of Year 2.see your table above and decide using NPV rule: accept positive NPV, reject negative net present valuescdMIRRr8%14%Economic Life(10?22) Economic LifeThe Scampini Supplies Company recently purchased a new delivery truck. The newtruck cost $22,500, and it is expected to generate net after-tax operating cash flows,including depreciation, of $6,250 per year. The truck has a 5 -year expected life. Theexpected salvage values after tax adjustments for the truck are given below. Thecompany's cost of capital is 1Inputsr10%Year012345AnnualTotal PVPV Cash PF SalvageOperating Salvage Valueper year DflowsValueCash Flow+E?$22,500$ 22,5006,25017,5006,25014,0006,25011,0006,2505,0006,2500Operate for 5 YearsOperate for 4 YearsOperate for 3 YearsOperate for 2 YearsOperate for 1 YearabNPVNPVNPVNPVNPV$0$0$0$0$0Year012345AnnualOperatingCash Flow?$22,5006,2506,2506,2506,2506,250Salvage Value$ 22,50017,50014,00011,0005,0000a. Should the firm operate the truck until the end of its 5-year physical life? If not,then what is its optimal economic life?b. Would the introduction of salvage values, in addition to operating cash flows, everreduce the expected NPV and/or IRR of a project?

 

Paper#57796 | Written in 18-Jul-2015

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