Concept explainers
To make capital budgeting decision, it is required that the asset and or projects are properly evaluated. This is done as follows:
Estimated the cash flows which is expected to be generated from the project or asset
Evaluate the riskiness of the project and determine an appropriate discount rate specific for the project
Determine the present value of all the expected cash flows, this is done by using the below equation
Here,
Expected net cash flow in Period t is “
Required rate of return is “r”
Now, compare the present value of future expected cash flows with the cost of the project. If the present value of
A capital budgeting project will generate $104,400 per year for four years. The two required
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- Yokam Company is considering two alternative projects. Project 1 requires an initial investment of $400,000 and has a present value of cash flows of $1,100,000. Project 2 requires an initial investment of $4,000,000 and has a present value of cash flows of $6,000,000. 1. Compute the profitability index for each project. 2. Based on the profitability index, which project should the company prefer? Complete this question by entering your answers in the tabs below. Required 1 Required 2 Compute the profitability index for each project. Project 1 Project 2 Choose Numerator: Profitability Index T 7 Choose Denominator: 4 of 5 180 # Next > G Oarrow_forwardSuppose that you are considering two projects and only have the financial resources to choose one project. Project A has an internal rate of return (IRR) of 14.5% and Project B, an IRR of 23.5%. The cost of capital is 12%. Explain whether the IRR capital budgeting technique is suitable for you to determine your project selection.arrow_forwardIvanhoe Manufacturing is evaluating two capital projects. The company's choice will be based on the profitability index. Project #1 has a present value of cash flows of $216,000 and a net initial investment of $194,400 while Project #2 has a present value of future cash flows of $885,600 and a net initial investment of $864,000. Click here to view the factor table. Using the present value tables, which project will Ivanhoe choose? (Round answers to 3 decimal places, e.g. 2.575.) Project #1 Project #2 Profitability Index Ivanhoe should choose since its profitability index is * than the profitability index ofarrow_forward
- Your company is currently considering two investment projects. Each project requires an upfront expenditure of $25 million. You estimate that the cost of capital is 10% and the investments will produce the after tax cash flows on the attached image . a)Calculate the payback period for both projects,then compare to identify which project the firm should undertake. b)Evaluate the advantages and disadvantages of using the payback method in investment decisions and assess the situations where it should be used .arrow_forwardYou are a financial analyst for the Hittle Company. The director of capital budgeting has asked you to analyze six proposed capital investments. Each project has a cost of $1,000, and the required rate of return for each is 12%, determine for each project (a) the payback period, (b) the net present value, (c) the profitability index, and (d) the internal rate of return. Assume under MACRS the asset falls in the three-year property class and that the corporate tax rate is 25 percent. You are limited to a maximum expenditure of $3000 only for this capital budgeting period. Which projects you will accept and why? Justify your suggestions Project A Project B Project C Project D Project E Project F Investment -1000 -1000 -1000 -1000 -1000 -1000 1 150 200 250 800 900 1000 2 350 300 250 350 300 200 3 400 500 600 200 150 100 4 700 650 600 200 150 50 12 Capital Budgeting and Estimating Cash Flows Table 12.2 PROPERTY CLASS RECOVERY YEAR MACRS depreciation percentages 3-YEAR 5-YEAR 7-YEAR 10-YEAR…arrow_forwardWinston Clinic is evaluating a project that costs $52, 125 and has expected net cash inflows of $12,000 per year for eight years. The first inflow occurs one year after the cost outflow, and the project has a cost of capital of 12 percent. What is the project's payback? What is the project's NPV? Its IRR? Its MIRR? Is the project financially acceptable? Explain your answer.arrow_forward
- Do the following problems. You must show your work. b) Find the IRR of the following projects and make your decision. Assume that the projects' cost of capital (or WACC) is 5%. Project X that costs $800 million is expected to generate $60m per year for 18 years. Is this project acceptable?Project Y that costs $100 million is expected to generate $22m per year for 7 years. Is this project acceptable?arrow_forwardA firm is reviewing a project that has an initial cost of $85,000. The project will produce cash inflows, starting with year 1, of $10,000, $15,500, $23,600, $30,100, and finally in year five, $38,700. What is the profitability index if the discount rate is 14 percent?arrow_forwardConsider the following two projects: (a) Calculate the profitability index for A1 and A2 at an interest rate of 6%.(b) Determine which project(s) you should accept (1) if you have enough money to undertake both and (2) if you could take only one due to a budget limit.arrow_forward
- Consider the following projects, X and Y where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 15 percent? Project X, since it has a higher NPV than Project Y Project Y, since it has a higher NPV than Project X neither, since both the projects have negative NPV neither, since both the projects have positive NPVarrow_forwardYou are evaluating a project that costs $75,000 today. The project has an inflow of $ 155,000 in one year and an outflow of $65,000 in two years. What are the IRRs for the project? What discount rate results in the maximum NPV for this project? How can you determine that this is the maximum NPV?arrow_forwardYokam Company is considering two alternative projects. Project 1 requires an initial investment of $470,000 and has a present value of all its cash flows of $2,350,000. Project 2 requires an initial investment of $5,000,000 and has a present value of all its cash flows of $6,000,000. (a) Compute the profitability index for each project. (b) Based on the profitability index, which project should the company select? Complete this question by entering your answers in the tabs below. Required A Required B Compute the profitability index for each project. Profitability Index Numerator: Denominator: Profitability Index = Profitability index Project 1 Project 2arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT