CAPITAL BUDGETING CRITERIA A firm with a 14% WACC is evaluating two projects for

Question

CAPITAL BUDGETING CRITERIA

A firm with a 14% WACC is evaluating two projects for this year's capital budget. After-tax cash flows, including depreciation, are as follows:

Calculate NPV for each project. Round your answers to the nearest cent. Do not round your intermediate calculations.
Project M    $
Project N    $

Calculate IRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M      %
Project N      %

Calculate MIRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M      %
Project N      %

Calculate payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M      years
Project N      years

Calculate discounted payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
Project M      years
Project N      years

Assuming the projects are independent, which one(s) would you recommend?
-Select-Only Project M would be accepted because NPV(M) > NPV(N).Only Project N would be accepted because NPV(N) > NPV(M).Both projects would be accepted since both of their NPV's are positive.Only Project M would be accepted because IRR(M) > IRR(N).Both projects would be rejected since both of their NPV's are negative.Item 11

If the projects are mutually exclusive, which would you recommend?
-Select-If the projects are mutually exclusive, the project with the highest positive NPV is chosen. Accept Project N.If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project M.If the projects are mutually exclusive, the project with the highest positive MIRR is chosen. Accept Project M.If the projects are mutually exclusive, the project with the shortest Payback Period is chosen. Accept Project M.If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project N.Item 12

Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?
-Select-The conflict between NPV and IRR is due to the fact that the cash flows are in the form of an annuity.The conflict between NPV and IRR is due to the difference in the timing of the cash flows.There is no conflict between NPV and IRR.The conflict between NPV and IRR occurs due to the difference in the size of the projects.The conflict between NPV and IRR is due to the relatively high discount rate.Item 13

0 1 2 3 4 5

Explanation / Answer

Statement showing NPV

For Project M

For project N

Statement showing IRR

For Project M

IRR is the rate where NPV is 0. At 19.858% NPV comes to 0 hence IRR = 19.858%

For project N

IRR is the rate where NPV is 0. At 16.7977% NPV comes to 0 hence IRR = 16.7977%

MIRR

For project M

MIRR = (FV of cash inflow/PV of cash outfloe)^1/n -1

FV of cash inflow =

MIRR = (52749/21000)^1/5 - 1

=1.2022 -1

=0.2022 i.e. 20.22%

For project N

Statement showing future cash flow

MIRR =(147696/63000)^0.2 - 1

1.1858-1

=0.1858 ie 18.58%

Payback period = Initial investment / cash flow

For project M = 21000/7000 = 3 years

For project N = 63000/19600 = 3.21 years

Project with highest NPV should be selected in case of mutually exclusive projects. There may exist confict betwwen IRR and NPV but we prefer NPV because of unrealistic assumptions of IRR

Thus project N should be selected

Year 1 2 3 4 5 Total After tax cash flow 7000.00 7000.00 7000.00 7000.00 7000.00 PVIF @14% 0.88 0.77 0.67 0.59 0.52 PV 6140.35 5386.27 4724.80 4144.56 3635.58 24032 Initial investment 21000 NPV 3032

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