Assume you are evaluating two mutually exclusive projects, the cash flows of which appear below and that your company uses a cost of capital of 13% to evaluate projects such as these. Time Project A Cash Flows Project B Cash Flows 0 -$46,800 -$63,600 1 -21,600 20,400 2 43,200 20,400 3 43,200 20,400 4 43,200 20,400 5 -28,800 20,400 Calculate the payback period and discounted payback period for projects A & B. Calculate the IRR and MIRR of projects A & B. Assume a reinvestment rate of 13% for the calculation of MIRR. Sketch the NPV profile for projects A & B. Determine the crossover point for these projects’ NPV profiles. Assuming a cost of capital of 14%, which of these projects should be accepted? Under what conditions on the cost of capital should project B be preferred to project A?
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Assume you are evaluating two mutually exclusive projects, the cash flows of which appear below and that your company uses a cost of capital of 13% to evaluate projects such as these.
|
Time |
Project A Cash Flows |
Project B Cash Flows |
|
0 |
-$46,800 |
-$63,600 |
|
1 |
-21,600 |
20,400 |
|
2 |
43,200 |
20,400 |
|
3 |
43,200 |
20,400 |
|
4 |
43,200 |
20,400 |
|
5 |
-28,800 |
20,400 |
- Calculate the payback period and discounted payback period for projects A & B.
- Calculate the
IRR and MIRR of projects A & B. Assume a reinvestment rate of 13% for the calculation of MIRR. - Sketch the
NPV profile for projects A & B. - Determine the crossover point for these projects’ NPV profiles.
- Assuming a cost of capital of 14%, which of these projects should be accepted?
- Under what conditions on the cost of capital should project B be preferred to project A?
- If Project A and Project B are independent, which project should be undertaken?
PLEASE ANSWER THE ONES IN BOLD (4,5,6)
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