Capital Budgeting Problems
3. Calculating Payback John’s Bakery Products, Inc., imposes a
payback cutoff of 2.5 years for its investment projects. If the
company has the following two projects available, should they accept
either of them?
Year
0
1
2
3
4
Answer: PaybackA= 1.56 years
Cash Flows A Cash Flows B
-$25,000
-$72,000
16,000
30,000
16,000
30,000
3,000
15,000
3,000
200,000
PaybackB=2.80 years
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Capital Budgeting Problems
4. Calculating Discounted Payback An investment project has
annual cash inflows of $500, $600, $700, and $800, and a discount
rate of 10 percent. What is the discounted payback period for
these cash flows if the initial cost is $1,000?
Answer: Discounted PaybackA= 2.09 years
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Capital Budgeting Problems
12. NPV versus IRR The Heitman Group, Inc., has identified the
following two mutually exclusive projects:
Year
0
1
2
3
4
Cash Flows L
Cash Flows S
-$10,000
-$10,000
200
5,000
500
6,000
8,200
500
4,800
500
a. What is the IRR for each of these projects? If you apply the IRR decision
rule, which project should the company accept? Is this decision necessarily
correct?
b. If the required return is 9 percent, what is the NPV for each of these
projects? Which project will you choose if you apply the NPV decision rule?
c. Over what range of discount rates would you choose Project L? Project S?
At what discount rate would you be indifferent between these two projects?
Answer: IRRL= 10.12%
Crossover rate=8.73%
IRRS=11.46% NPVL=$336.67 NPVS=$377.54
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Capital Budgeting Problems
13. NPV versus IRR Consider the two mutually exclusive
projects below:
Year
0
1
2
3
Cash Flows M Cash Flows N
-$50
-$50
40
5
20
5
5
65
Sketch the NPV profiles for M and N over a range of discount rates
from zero to 25 percent. What is the crossover rate for these two
projects?
Answer: Crossover rate=11.24%
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Capital Budgeting Problems
29. NPV Intuition Projects A and B have the same cost, and
both have conventional cash flows. The total undiscounted cash
inflows for A are $1,900, and for B the total is $1,500. The IRR for
A is 18 percent; the IRR for B is 15 percent. What can you
deduce about the NPVs for Projects A and B? What do you know
about the crossover rate? Under what circumstances would you
choose Project A over Project B? How about B over A?
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Capital Budgeting Problems
33. NPV Valuation The Grim Reaper Corporation wants to set up
a private cemetery business. The cemetery project will provide a
net cash inflow of $25,000 for the firm during the first year, and
these cash flows are projected to grow at a rate of 6 percent per
year forever (the Grim Reaper keeps pretty busy). The project
requires an initial investment of $400,000.
a. If the Grim Reaper requires a 12 percent return on investment, should
the cemetery business be started?
b. The company is somewhat unsure about the assumption of a 6 percent
growth rate in its cash flows. At what constant growth rate would the
company just break even if it still requires a 12 percent return on
investment?
Answer: NPV=$16,667 g=5.75%
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