(Part 1) Using a 4.5% discount rate, calculate the Net Present Value, Payback, P
ID: 2417454 • Letter: #
Question
(Part 1)
Using a 4.5% discount rate, calculate the Net Present Value, Payback, Profitability Index, and IRR for each of the investment projects below (note, the inflows are for each year). Based on your calculations rank the projects and support you answer.
Project 1
Initial Invest= $490,000, Cash inflows of $100,000 for years 1-5 and $50,000 for years 6-10.
Project 2
Initial Invest= $970,000, Cash inflows of $400,000 for years 1-3, $0 for years 4-7 and $250,000 for years 8-10.
Project 3
Initial Invest= $820,000, Cash inflows of $300,000 for years 1-5, $0 for years 6-9 and $100,000 for year 10.
(Part 2)
Assuming a budget of $1,100,000 what are your recommendations for the three projects in the above problem. Explain.
Assuming a budget of $2,200,000 what are your recommendations for the above problem? Explain.
Explanation / Answer
Project-1 Project-2 Project-3 Year PV factor @ 4.5% Cash Flow Discounted Cash Flow Cash Flow Discounted Cash Flow Cash Flow Discounted Cash Flow 1 0.9569 100000 95,693.78 400000 382,775.12 300000 287,081.34 2 0.9157 100000 91,573.00 400000 366,291.98 300000 274,718.99 3 0.8763 100000 87,629.66 400000 350,518.64 300000 262,888.98 4 0.8386 100000 83,856.13 0 - 300000 251,568.40 5 0.8025 100000 80,245.10 0 - 300000 240,735.31 6 0.7679 50000 38,394.79 0 - 0 - 7 0.7348 50000 36,741.42 0 - 0 - 8 0.7032 50000 35,159.26 250000 175,796.28 0 - 9 0.6729 50000 33,645.22 250000 168,226.11 0 - 10 0.6439 50000 32,196.38 250000 160,981.92 100000 64,392.77 PV of Cash Inflow 615,135 1,604,590 1,381,386 Less: Initial Investment 490,000 970,000 820,000 NPV 125,135 634,590 561,386 Ranking III I II Payback Period = Initial Investment ÷ Annual Cash Flow Profitability Index = Present Value of Benefits / Present value of Costs Payback Period 4.90 2.43 2.73 (In Years) PI 1.26 1.65 1.68 Ranking III II I The IRR is the discount rate at which the NPV for a project equals zero. value of its outflows. This rate means that the present value of the cash inflows for the project would equal the present IRR = PV of Inflow /1+R = NPV R = PV of Inflow / NPV - 1 IRR 39.16 15.29 14.61 Ranking I II III Conclusions Different businesses will use different valuation methods to either accept or reject capital budgeting projects. Although the NPV method is considered the favorable one among analysts, the IRR and PB are often used as well under certain circumstances. Managers can have the most confidence in their analysis when all three approaches indicate the same course of action. Note: Decisions is beased on two situation Situation -1 : If the above 3 projects are Indivisable Projects. Part-1 : Budget - 11,000,00 - Then invest in Project-2 (Based on NPV Ranking) and Remaining Balance either return to investor or Invest in risk free securities like Govt Bonds. Part-2 : Budget - 22,000,00 - Then invest in Project-2 & 3 (Based on NPV Ranking) and Remaining Balance either return to investor or Invest in risk free securities like Govt Bonds. Situation -2 : If the above 3 projects are divisable Projects. Part-1 : Budget - 11,000,00 - Then invest in Project-2 - $ 9,70,000 and $ 1,30,000 in Project -3. (Based on NPV Ranking) Part- 2: Budget - 22,000,00 - Then invest in Project-2 - $ 9.70,000 ,$ 8,20,000 in Project -3 and $ 4,10,000 in Project-1. (Based on NPV Ranking)
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