Capital Budgeting Process and Techniques for which project would you recommend a
ID: 2805211 • Letter: C
Question
Capital Budgeting Process and Techniques for which project would you recommend acceptance? The first 3 Calculate the internal rate of return (IRR) proposal calls for a major renovation of the of each project, and based on this criteria, for which project would you recommend involves replacing just a few obsolete pieces of 4. Calculate the profitability index (PD) of The second equipment in the facility. The company will each project, and based on this criteria, for which project would you recommend acceptance? choose one project or the other this year, but it will not do both. The cash flows associated with each project appear below and the firm discounts project cash flows at 15 percent 5. Overal I, you should find ommendations based on the various cri- teria. Why is this occurring? 6. Chart the NPV profiles of these projects. -$2,400,000 Labe the intersection points on the X 2,000,000 and Yaxis and the crossover point. 200,000 200,000 7. Based on this NPV profile analysis and assuming the WACC is 15%, which s recom 8. Assignment 1. Calculate the payback period of each proj- Based on this NPV profile analysis and assuming the WACC is 25%, which proj- ect is ? Why? ect, and based on this criteria, for which 9. Discuss the important elements to con- project would you recommend accep-sider when deciding between these two 2. Calculate the net present value (NPV) of each project, and based on this criteria,Explanation / Answer
1-
renovate
Replace
Year
cash flow
Year
cash flow
cumulative cash flow
0
9000000
0
2400000
1
3000000
1
2000000
2000000
2
3000000
2
800000
400000
amount to be recovered
3
3000000
3
200000
4
3000000
4
200000
5
3000000
5
200000
Payback period in Years = initial investment/annual cash flow
9000000/3000000
3
payback period
year before the final recovery+(amount to be recovered/cash flow of the year of recovery)
1+(400000/800000)
1.5
Replace should be done as its payback period is less than renovate
2-
renovate
Replace
Year
cash flow
present value of cash inflow = cash inflow/(1+r)^n r= 15%
Year
cash flow
present value of cash inflow = cash inflow/(1+r)^n r= 15%
0
-9000000
-9000000
0
2400000
-2400000
1
3000000
2608696
1
2000000
1739130
2
3000000
2268431
2
800000
604914.9
3
3000000
1972549
3
200000
131503.2
4
3000000
1715260
4
200000
114350.6
5
3000000
1491530
5
200000
99435.35
net present value
sum of present value of cash flow
1056465
net present value
sum of present value of cash flow
289334.6
renovate is the preferred option on the basis of NPV as its NPV is greater than Replace
4-
renovate
Replace
Year
cash flow
present value of cash inflow = cash inflow/(1+r)^n r= 15%
Year
cash flow
present value of cash inflow = cash inflow/(1+r)^n r= 15%
0
-9000000
-9000000
0
2400000
-2400000
1
3000000
2608696
1
2000000
1739130
2
3000000
2268431
2
800000
604914.9
3
3000000
1972549
3
200000
131503.2
4
3000000
1715260
4
200000
114350.6
5
3000000
1491530
5
200000
99435.35
sum of present value of cash inflow
10056465
sum of present value of cash inflow
2689335
cash outflow
9000000
cash outflow
2400000
profitability index
sum of present value of cash inflow/cash outflow
1.117385
profitability index
sum of present value of cash inflow/cash outflow
1.120556
renovate is the preferred option on the basis of PI as its PI is greater than Replace
3-
renovate
Replace
Year
cash flow
Year
cash flow
0
-9000000
0
-2400000
1
3000000
1
2000000
2
3000000
2
800000
3
3000000
3
200000
4
3000000
4
200000
5
3000000
5
200000
IRR using IRR function in MS excel spreadsheet =irr(-9000000,3000000,3000000,3000000,3000000,3000000)
19.86%
IRR using IRR function in MS excel spreadsheet =irr(-2400000,2000000,800000,200000,200000,200000)
23.69%
replacement is the preferred option on the basis of IRR as its IRRis greater than Renovate
1-
renovate
Replace
Year
cash flow
Year
cash flow
cumulative cash flow
0
9000000
0
2400000
1
3000000
1
2000000
2000000
2
3000000
2
800000
400000
amount to be recovered
3
3000000
3
200000
4
3000000
4
200000
5
3000000
5
200000
Payback period in Years = initial investment/annual cash flow
9000000/3000000
3
payback period
year before the final recovery+(amount to be recovered/cash flow of the year of recovery)
1+(400000/800000)
1.5
Replace should be done as its payback period is less than renovate
2-
renovate
Replace
Year
cash flow
present value of cash inflow = cash inflow/(1+r)^n r= 15%
Year
cash flow
present value of cash inflow = cash inflow/(1+r)^n r= 15%
0
-9000000
-9000000
0
2400000
-2400000
1
3000000
2608696
1
2000000
1739130
2
3000000
2268431
2
800000
604914.9
3
3000000
1972549
3
200000
131503.2
4
3000000
1715260
4
200000
114350.6
5
3000000
1491530
5
200000
99435.35
net present value
sum of present value of cash flow
1056465
net present value
sum of present value of cash flow
289334.6
renovate is the preferred option on the basis of NPV as its NPV is greater than Replace
4-
renovate
Replace
Year
cash flow
present value of cash inflow = cash inflow/(1+r)^n r= 15%
Year
cash flow
present value of cash inflow = cash inflow/(1+r)^n r= 15%
0
-9000000
-9000000
0
2400000
-2400000
1
3000000
2608696
1
2000000
1739130
2
3000000
2268431
2
800000
604914.9
3
3000000
1972549
3
200000
131503.2
4
3000000
1715260
4
200000
114350.6
5
3000000
1491530
5
200000
99435.35
sum of present value of cash inflow
10056465
sum of present value of cash inflow
2689335
cash outflow
9000000
cash outflow
2400000
profitability index
sum of present value of cash inflow/cash outflow
1.117385
profitability index
sum of present value of cash inflow/cash outflow
1.120556
renovate is the preferred option on the basis of PI as its PI is greater than Replace
3-
renovate
Replace
Year
cash flow
Year
cash flow
0
-9000000
0
-2400000
1
3000000
1
2000000
2
3000000
2
800000
3
3000000
3
200000
4
3000000
4
200000
5
3000000
5
200000
IRR using IRR function in MS excel spreadsheet =irr(-9000000,3000000,3000000,3000000,3000000,3000000)
19.86%
IRR using IRR function in MS excel spreadsheet =irr(-2400000,2000000,800000,200000,200000,200000)
23.69%
replacement is the preferred option on the basis of IRR as its IRRis greater than Renovate
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