1- A firm is evaluating an investment that costs $90,000 and is expected to gene

Question

1- A firm is evaluating an investment that costs $90,000 and is expected to generate annual cash flows equal to $20,000 for the next 6 years. If the firms required rate if return is 10 percent, what is the net present value (NPV) of the project? What is the internal rate of return? Should the project be purchased?

2-What is the traditional payback period (PB) of a project that costs $450,000 if it is expected to generate $120,000 per year for five years? If the firms required rate if return is 11 percent, what is the projects discounted payback period (DPB)?

3-Compute the internal rate of return and the modified internal rate of return for each of the following capital budgeting projects. The firms required rate of return is 14%.

year project G Project J Project K

0 $(180,000) $(240,000) $(200,000)

1 80,100 0 (100,000)

2 80,100 0 205,000

3 80,100 368,500 205,000

Which projects should be the purchase if all are independent? Which project should be purchased if they are mutually exclusive?

4- Following are the estimated after-tax cash flows for two mutually exclusive projects:

Following are the estimated after-tax cash flows for two mutually exclusive projects:

year Machine D Machine Q

0 $(32,500) $(29,800)

1 20,500 4,000

2 10,000 9,000

3 6,500 16,000

4 7,800 19,500

The company's rate of return is 16 percent. What is the internal rate of return (IRR) of the projects the company shoul purchase?

5- Compute the (a) NPV, (b) IRR, (c) MIRR, and (d) discounted payback for the following independent capital budgeting projects. (r=9%)

year Project T Project U

0 $(8,000) $(10,000)

1 2,000 9,000

2 1,000 5,000

3 7,000 (3,100)

Which project(s) should the company purchase? why?

Explanation / Answer

1) Cashfow would be -90,000,20000,20000,20000,20000,20000,20000 and r=10%=0.1

NPV= -90000 + 20000/(1+0.1) +20000/(1+0.1)^2 + 20000/(1+0.1)^3 + 20000/(1+0.1)^4 + 20000/(1+0.1)^5 + 20000/(1+0.1)^6

=-2894.79

For IRR Calculation let say IRR=i then at r=i % the NPV should be equal to zero.

-90000 + 20000/(1+i) +20000/(1+i)^2 + 20000/(1+i)^3 + 20000/(1+i)^4 + 20000/(1+i)^5 + 20000/(1+i)^6 = 0

on solving i=0.089 or 8.9%

The project shouldn't purchased.

2)Payback Period = Cost of Project / Average Annual Cash Inflows = 450000/120000=3.75 years

Discounted payback period= [ln(1/ (1- (initial investment*rate/periodic cash flow)))] / ln(1+rate)

Initial investment=450000 Cash flow periodic=120000 rate=0.11 on putting the values

DPP comes out to be 5.097 years.

3) For Project G

IRR is calculated as

-180000 + 80100/(1+r) + 80100/(1+r)^2 + 80100/(1+r)^3 = 0

on solving r=15.97%

MIRR will be as same as IRR because negative cash flow takes place only at single time.

For Project J

IRR Calculation:

-240000+368500/(1+i)^3=0

i .i. IRR = 15.37%

and MIRR= IRR as negative cashflow took placee at the starting of project i.e for single time only.

For project K

IRR:

-200000-100000/(1+i) + 205000/(1+i)^2 + 205000/(1+i)^3 =0

i .e. IRR=15.53%

MIRR=15.37%

If all are independent then Project G should be undertaken and if they are mutually exclusive projects then that project will be chosen who have the higher NPV.

Similarly you can attempt other two parts also.

MIRR is calculated with the fomula:

MIRR= {[FV(Positive cashflows, reinvestment rate(irr))/ -PV(negative cashflows, finance rate)]^(1/no of years) }- 1

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