Capital Budgeting Process and Techniques for which project would you recommend a
ID: 2805603 • 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.
Calculate the payback period:
Replace:
Year
Disc. Factor @ 15%
Replace
Disc. Cash flows
Cumulative Cash flow
1
0.869565217
$ 2,000,000
$ 1,739,130
$ 1,739,130
2
0.756143667
$ 800,000
$ 604,915
$ 2,344,045
3
0.657516232
$ 200,000
$ 131,503
$ 2,475,549
4
0.571753246
$ 200,000
$ 114,351
$ 2,589,899
5
0.497176735
$ 200,000
$ 99,435
$ 2,689,335
Renovate:
Year
Disc. Factor @ 15%
Renovate
Disc. Cash flows
Cumulative Cash flow
1
0.869565217
$ 3,000,000
$ 2,608,696
$ 2,608,696
2
0.756143667
$ 3,000,000
$ 2,268,431
$ 4,877,127
3
0.657516232
$ 3,000,000
$ 1,972,549
$ 6,849,675
4
0.571753246
$ 3,000,000
$ 1,715,260
$ 8,564,935
5
0.497176735
$ 3,000,000
$ 1,491,530
$ 10,056,465
Conclusion:
It is better to renovate the project as payback period is less compared to replace alternative.
2.
Calculate NPV:
Year
Disc. Factor @ 15%
Replace
Cash flow
0
1.000000000
$ -2,400,000
$ -2,400,000
1
0.869565217
$ 2,000,000
$ 1,739,130
2
0.756143667
$ 800,000
$ 604,915
3
0.657516232
$ 200,000
$ 131,503
4
0.571753246
$ 200,000
$ 114,351
5
0.497176735
$ 200,000
$ 99,435
NPV
$ 289,335
NPV Calculation:
Year
Disc. Factor @ 15%
Renovate
Cash flow
0
1.000000000
$ -9,000,000
$ -9,000,000
1
0.869565217
$ 3,000,000
$ 2,608,696
2
0.756143667
$ 3,000,000
$ 2,268,431
3
0.657516232
$ 3,000,000
$ 1,972,549
4
0.571753246
$ 3,000,000
$ 1,715,260
5
0.497176735
$ 3,000,000
$ 1,491,530
NPV
$ 1,056,465
It is better to renovate the project as NPV is more in this alternative.
3.
Calculate IRR:
Year
Disc. Factor @ 15%
Replace
Cash flow
Disc. Factor @ 25%
Cash
flows
0
1.000000000
$ -2,400,000
$ -2,400,000
1.0000000000
$ -2,400,000
1
0.869565217
$ 2,000,000
$ 1,739,130
0.8000000000
$ 1,600,000
2
0.756143667
$ 800,000
$ 604,915
0.6400000000
$ 512,000
3
0.657516232
$ 200,000
$ 131,503
0.5120000000
$ 102,400
4
0.571753246
$ 200,000
$ 114,351
0.4096000000
$ 81,920
5
0.497176735
$ 200,000
$ 99,435
0.3276800000
$ 65,536
NPV
$ 289,335
0.2621440000
$ -38,144
Calculate IRR:
Year
Disc. Factor @ 15%
Renovate
Cash flow
Disc. Factor @ 25%
Cash flows
0
1.000000000
$ -9,000,000
$ -9,000,000
1.0000000000
$ -9,000,000
1
0.869565217
$ 3,000,000
$ 2,608,696
0.8000000000
$ 2,400,000
2
0.756143667
$ 3,000,000
$ 2,268,431
0.6400000000
$ 1,920,000
3
0.657516232
$ 3,000,000
$ 1,972,549
0.5120000000
$ 1,536,000
4
0.571753246
$ 3,000,000
$ 1,715,260
0.4096000000
$ 1,228,800
5
0.497176735
$ 3,000,000
$ 1,491,530
0.3276800000
$ 983,040
NPV
$ 1,056,465
0.2621440000
$ -932,160
It is better to accept the project for renovation as IRR is comparatively more.
Year
Disc. Factor @ 15%
Replace
Disc. Cash flows
Cumulative Cash flow
1
0.869565217
$ 2,000,000
$ 1,739,130
$ 1,739,130
2
0.756143667
$ 800,000
$ 604,915
$ 2,344,045
3
0.657516232
$ 200,000
$ 131,503
$ 2,475,549
4
0.571753246
$ 200,000
$ 114,351
$ 2,589,899
5
0.497176735
$ 200,000
$ 99,435
$ 2,689,335
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