Cash Flows (in thousands of USD) Year 0 1 2 3 4 5 6 7 Project 1 -100 10 20 0 0 1
ID: 2774227 • Letter: C
Question
Cash Flows (in thousands of USD)
Year
0
1
2
3
4
5
6
7
Project 1
-100
10
20
0
0
110
0
0
Project 2
-100
0
0
0
40
50
80
10
Project 3
-250
0
15
20
30
40
150
110
Project 4
-500
150
150
-100
50
100
150
200
Project 5
-400
100
100
-100
200
200
-80
130
In the above table, five projects were proposed from different departments of the firm trying to compete for the total $1,000,000 capital budget for next year. The CFO made it clear at the meeting that any project with zero or negative NPV should not be funded. Given it is a pharmaceutical firm, the CFO and the key managers are used to concepts of investing in the long-term projects and/or relatively risky projects, and/or projects with volatile cash flows over time. In addition, most of the members on the committee are cautiously optimistic about the future outlook of the economy. Around the time of the meetings, there were rumors that the Federal Reserve Bank is considering increasing the prime interest rates.
1) Would your capital budgeting decisions change if the discount rate is changed to 8%? Why?
Cash Flows (in thousands of USD)
Year
0
1
2
3
4
5
6
7
Project 1
-100
10
20
0
0
110
0
0
Project 2
-100
0
0
0
40
50
80
10
Project 3
-250
0
15
20
30
40
150
110
Project 4
-500
150
150
-100
50
100
150
200
Project 5
-400
100
100
-100
200
200
-80
130
Explanation / Answer
Project 0 1 2 3 4 5 6 7 NPV 1 -100 10 20 0 0 110 0 0 40 2 -100 0 0 0 40 50 80 10 80 3 -250 0 15 20 30 40 150 110 115 4 -500 150 150 -100 50 100 150 200 200 5 -400 100 100 -100 200 200 -80 130 150 The investment should be Project 4 500 Project 5 400 Project 2 100 Project 0 1 2 3 4 5 6 7 NPV 1 1 -100 -100 10 10 20 20 0 0 0 0 110 110 0 0 0 0 40 0 2 0.925926 -100 -92.5926 0 0 0 0 0 0 40 37.03704 50 46.2963 80 74.07407 10 9.259259 74.07407 0 0 0 0 0 0 0 0 3 0.857339 -250 -214.335 0 0 15 12.86008 20 17.14678 30 25.72016 40 34.29355 150 128.6008 110 94.30727 98.59396 0 0 0 0 0 0 0 0 4 0.793832 -500 -396.916 150 119.0748 150 119.0748 -100 -79.3832 50 39.69161 100 79.38322 150 119.0748 200 158.7664 158.7664 0 0 0 0 0 0 0 0 5 0.73503 -400 -294.012 100 73.50299 100 73.50299 -100 -73.503 200 147.006 200 147.006 -80 -58.8024 130 95.55388 110.2545 No the decision will not be changed
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