Capital Budgeting Process and Techniques for which project would you recommend a

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. Cash Payback Period :

Renovate : 3 years.

Cash payback period = Initial Investment / Average Annual Cash Flows = $ 9,000,000 / $ 3,000,000 = 3 years.

Replace : 1.5 years.

Cash payback period = 1 + $ 400,000 / $ 800,000 = 1.5 years.

2. NPV : Discount Rate 15%

Renovate : $ 1,056,600

NPV = $ 3000,000 x 3.3522 - $ 9000,000 = $ 1,056,600.

Replace : $ 289,342.

NPV = $ 2,000,000 x 0.86957 + $ 800,000 x 0.75614 + $ 200,000 x ( 0.65752 + 0.57175 + 0.49718) - $ 2,400,000 = $ 1,739,140 + $ 604,912 + $ 345,290 - $ 2,400,000 = $ 289,342.

3. IRR:Excel

Renovate : 20%

Replace : 24 %

4. PI = Present Value of Cash Inflows / Initial Investment

Renovate : 1.1174

PI = $ ( 3,000,000 x 3.3522 ) / $ 9,000,000 = 1.1174

Replace : 1.1206

PI = $ ( 1,739,140 + 604,912 + 345,290) / $ 2,400,000 = 1.1206

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