Sub: Accounts

Topic: CapitalBudgeting

Question:
Henn Corp, Ltd. is examining two investment projects as a part of its expansion plan for the coming year. These two projects are not mutually exclusive. The cost of Project A is $12,950 while the second project (B) is expected to cost $18,625. Henn's cost of capital (required rate of return) is 11.5 %. Expected annual cash flows are projected to be as follows:
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Year project A Project B 1 2 3 4 5 3,250.00 3,250.00 3,250.00 3,250.00 3,250.00 6,850.00 6,850.00 6,850.00 6,850.00 6,850.00

Each project will last an estimated 5 years with no remaining significant scrap value. Determine the IRR and the NPV for each of these two projects. What should Henn Corp decide about each proposed project

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Sub: Accounts

Topic: CapitalBudgeting

Solution:

Project A Project B Cost of capital (required rate of return) Details of Cash flow Year 1 2 3 4 5

Initial cost $12,950 $18,625 11.50%

Project A $3,250 $3,250 $3,250 $3,250 $3,250

Project B $6,850 $6,850 $6,850 $6,850 $6,850

Project A Computation of NPV and IRR Particulars Initial cost Cash inflows Net cash flows Discounting factor @11.50% Discounted net cash flows NPV IRR

0 -$12,950 0 -$12,950

1 $0 $3,250 $3,250

2 $0 $3,250 $3,250

3 $0 $3,250 $3,250

4 $0 $3,250 $3,250

5 $0 $3,250 $3,250

1.0000 0.8969 0.8044 0.7214 0.6470 0.5803 $12,950.00 $2,914.80 $2,614.17 $2,344.55 $2,102.73 $1,885.86 -$1,087.90 8.08%
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Sub: Accounts

Topic: CapitalBudgeting

Project B Computation of NPV and IRR Particulars Initial cost Cash inflows Net cash flows Discounting factor @11.50% Discounted net cash flows NPV IRR

0 -$18,625 $0 -$18,625

1 $0 $6,850 $6,850

2 $0 $6,850 $6,850

3 $0 $6,850 $6,850

4 $0 $6,850 $6,850

5 $0 $6,850 $6,850

1.0000 0.8969 0.8044 0.7214 0.6470 0.5803 $18,625.00 $6,143.50 $5,509.86 $4,941.58 $4,431.91 $3,974.81 $6,376.66 24.47%

The NPV for Project A is negative. So project A should not be accepted. The NPV for Project B is positive, as such Project B should be accepted

** End of the Solution **

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