1. (Capital Budgeting) 4 points Show all work and formulas used. Consider Projec
ID: 2756155 • Letter: 1
Question
1. (Capital Budgeting) 4 points
Show all work and formulas used.
Consider Projects A and B, with net cash flows as follows:
---- Net Cash Flows ----
Project A Project B
Initial Cost at T-0 (Now) ($30,000) ($50,000)
cash inflow at the end of year 1 10,000 6,000
cash inflow at the end of year 2 8,000 16,000
cash inflow at the end of year 3 5,000 25,000
a. Construct NPV Profiles for these two projects.
b. If the two projects were mutually exclusive, which would you accept if your firm’s cost of capital were 4%? Which would you accept if your firm’s cost of capital were 8%?
Explanation / Answer
1
Calculation of NPV (if your firm’s cost of capital were 4%):
Project A
Cash Flows (CF)
PVF (4%)
PV = CF*PVF
Initial Cost at T-0 (Now)
$ (30,000)
1.00000
$ (30,000.00)
Cash inflow at the end of year 1
$ 10,000
0.96154
$ 9,615.38
Cash inflow at the end of year 2
$ 8,000
0.92456
$ 7,396.45
Cash inflow at the end of year 3
$ 5,000
0.88900
$ 4,444.98
NPV
$ (8,543.18)
Project B
Cash Flows (CF)
PVF (4%)
PV = CF*PVF
Initial Cost at T-0 (Now)
$ (50,000)
1.00000
$ (50,000.00)
Cash inflow at the end of year 1
$ 6,000
0.96154
$ 5,769.23
Cash inflow at the end of year 2
$ 16,000
0.92456
$ 14,792.90
Cash inflow at the end of year 3
$ 25,000
0.88900
$ 22,224.91
NPV
$ (7,212.96)
AT Cost of Capital 4%, both projects give negative NPV, hence we should reject both projects.
2
Calculation of NPV (if your firm’s cost of capital were 8%):
Project A
Cash Flows (CF)
PVF (8%)
PV = CF*PVF
Initial Cost at T-0 (Now)
$ (30,000)
1.00000
$ (30,000.00)
Cash inflow at the end of year 1
$ 10,000
0.92593
$ 9,259.26
Cash inflow at the end of year 2
$ 8,000
0.85734
$ 6,858.71
Cash inflow at the end of year 3
$ 5,000
0.79383
$ 3,969.16
NPV
$ (9,912.87)
Project B
Cash Flows (CF)
PVF (8%)
PV = CF*PVF
Initial Cost at T-0 (Now)
$ (50,000)
1.00000
$ (50,000.00)
Cash inflow at the end of year 1
$ 6,000
0.92593
$ 5,555.56
Cash inflow at the end of year 2
$ 16,000
0.85734
$ 13,717.42
Cash inflow at the end of year 3
$ 25,000
0.79383
$ 19,845.81
NPV
$ (10,881.22)
AT Cost of Capital 8%, both projects give negative NPV, hence we should reject both projects.
1
Calculation of NPV (if your firm’s cost of capital were 4%):
Project A
Cash Flows (CF)
PVF (4%)
PV = CF*PVF
Initial Cost at T-0 (Now)
$ (30,000)
1.00000
$ (30,000.00)
Cash inflow at the end of year 1
$ 10,000
0.96154
$ 9,615.38
Cash inflow at the end of year 2
$ 8,000
0.92456
$ 7,396.45
Cash inflow at the end of year 3
$ 5,000
0.88900
$ 4,444.98
NPV
$ (8,543.18)
Project B
Cash Flows (CF)
PVF (4%)
PV = CF*PVF
Initial Cost at T-0 (Now)
$ (50,000)
1.00000
$ (50,000.00)
Cash inflow at the end of year 1
$ 6,000
0.96154
$ 5,769.23
Cash inflow at the end of year 2
$ 16,000
0.92456
$ 14,792.90
Cash inflow at the end of year 3
$ 25,000
0.88900
$ 22,224.91
NPV
$ (7,212.96)
AT Cost of Capital 4%, both projects give negative NPV, hence we should reject both projects.
2
Calculation of NPV (if your firm’s cost of capital were 8%):
Project A
Cash Flows (CF)
PVF (8%)
PV = CF*PVF
Initial Cost at T-0 (Now)
$ (30,000)
1.00000
$ (30,000.00)
Cash inflow at the end of year 1
$ 10,000
0.92593
$ 9,259.26
Cash inflow at the end of year 2
$ 8,000
0.85734
$ 6,858.71
Cash inflow at the end of year 3
$ 5,000
0.79383
$ 3,969.16
NPV
$ (9,912.87)
Project B
Cash Flows (CF)
PVF (8%)
PV = CF*PVF
Initial Cost at T-0 (Now)
$ (50,000)
1.00000
$ (50,000.00)
Cash inflow at the end of year 1
$ 6,000
0.92593
$ 5,555.56
Cash inflow at the end of year 2
$ 16,000
0.85734
$ 13,717.42
Cash inflow at the end of year 3
$ 25,000
0.79383
$ 19,845.81
NPV
$ (10,881.22)
AT Cost of Capital 8%, both projects give negative NPV, hence we should reject both projects.
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