Question 5 Basics of Capital Budgeting Assume a $200,000 investment and the foll

Question

Question 5 Basics of Capital Budgeting

Assume a $200,000 investment and the following cash flow for two products .

Here are the products’ net cash flows (in thousands of dollars):

                                   0                      1                      2                 3                4

                                   |                      |                      

Product L           -200,000      60,000               90,000        50,000            40,000

Product S           -200,000      40,000                   70,000         80,000           80,000

Which alternative would you select, show work.

Also, what is the NPV and IRR?

Explanation / Answer

Answer:

Assume = Required rate of return:

IRR can be obtained using the excel function of IRR:

Product S should be choosen for it's positive NPV and an IRR in excess of required rate of return.

In 000' $ In 000' $ Year Product L Product S Discount rate@10% Discounted Cashflow L Discounted Cashflow S 0 -200000 -200000 1.0000 -200000 -200000 1 60000 40000 0.9091 54546 36364 2 90000 70000 0.8264 74376 57848 3 50000 80000 0.7513 37565 60104 4 40000 80000 0.6830 27320 54640 NPV= -6193 8956 IRR= 8.44% 11.85%

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