BASICS OF CAPITAL BUDGETING HOMEWORK

Name:

1. You are a financial analyst for the Vincenzo Company. The director of capital budgeting has
asked you to analyze two proposed capital investments, Projects X and Y. Each project has a
cost of $10,000, and the cost of capital for each project is 12%. The projects’ expected net
cash flows are as follows:
Expected Net Cash Flows

Year Project X Project Y

0 ($10,000) ($10,000)
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500

a. Calculate each project’s payback period, net present value (NPV), internal rate of
return (IRR), and modified internal rate of return (MIRR).

b. Which project or projects should be accepted if they are independent?

c. Which project should be accepted if they are mutually exclusive?

d. How might a change in the cost of capital produce a conflict between the NPV and
IRR rankings of these two projects? Would this conflict exist if r were 5%? (Hint: Plot
the NPV profiles.)

e. Why does the conflict exist?

2. A project has an initial cost of $52,125, expected net cash inflows of $12,000 per year for 8
years, and a cost of capital of 12%. What is the project’s NPV? (Hint: Begin by constructing a
time line.)

a. Refer to Problem 11-1. What is the project’s IRR?

b. Refer to Problem 11-1. What is the project’s MIRR?
c. Refer to Problem 11-1. What is the project’s PI?
d. Refer to Problem 11-1. What is the project’s payback period?
e. Refer to Problem 11-1. What is the project’s discounted payback period?
3. Cha Young Products Company is considering two mutually exclusive investments. The
projects’ expected net cash flows are as follows:

Expected Net Cash Flows

Year Project A Project B
0 ($300) ($405)
1 (387) 134
2 (193) 134
3 (100) 134
4 600 134
5 600 134
6 850 134
7 (180) 0

a. Construct NPV profiles for Projects A and B.

b. What is each project’s IRR?
c. If you were told that each project’s cost of capital was 10%, which project
d. should be selected? If the cost of capital was 17%, what would be the proper
e. choice?
f. What is each project’s MIRR at a cost of capital of 10%? At 17%? (Hint:
g. Consider Period 7 as the end of Project B’s life.)
h. What is the crossover rate, and what is its significance?

4. Your division is considering two investment projects, each of which requires an upfront
expenditure of $25 million. You estimate that the cost of capital is 10% and that the
investments will produce the following after-tax cash flows (in millions of dollars):

Year Project A Project B

1 5 20

2 10 10

3 15 8

4 20 6

a. What is the regular payback period for each of the projects?

b. What is the discounted payback period for each of the projects?
c. If the two projects are independent and the cost of capital is 10%, which project
or projects should the firm undertake?
d. If the two projects are mutually exclusive and the cost of capital is 5%, which
e. project should the firm undertake?
f. If the two projects are mutually exclusive and the cost of capital is 15%, which
g. project should the firm undertake?
h. What is the crossover rate?
i. If the cost of capital is 10%, what is the modified IRR (MIRR) of each project?