FINA 2201 Chapter Notes - Chapter 11: Net Present Value, Cash Flow, Capital Budgeting

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lilacmule890

14 Mar 2016

School

Northeastern University

Department

Finance & Insurance

Course

FINA 2201

Professor

Sidi Boubker Drissi Messouak

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Document Summary

Similar to security valuation except: the investor (the firm) has an influence on cash flows, whereas securities are traded in the open market firms create capital budgeting projects. Categories of projects: replacement needed to continue current operations, replacement cost reduction, expansion of existing products or market, expansion into new products or markets, safety and or environmental projects, other projects, mergers. Criteria for accepting projects: net present value, internal rate of return, modified internal rate of return, regular payback, discounted payback (cid:1) The value of a project is the present value of a project"s free cash flows discounted at the cost of capital: the most difficult part is estimating the relevant cash flows. Find the npv as follows: the present value of each cash flow is calculated and discounted at the project"s risk-adjusted cost of capital r, the sum of the discounted cash flows is defined as the project"s npv.

Related Questions

You are a financial analyst for the Waffle Company. The director of capital budgeting has asked you to analyze two proposed capital investments, Projects A and B. Each project has a cost of $50,000, and the cost of capital for each is 10%.

The projects’ expected net cash flows are as follows:

	Expected Net Cash Flows
Year	Project A	Project B
0	($50,000)	($50,000)
1	25,000	15,000
2	20,000	15,000
3	10,000	15,000
4	5,000	15,000
5	5,000	15,000

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

peachturtle69

Q6) Assume yourself as a financial analyst for the Great Land Company. Then, the director of capital budgeting asks you to analyse two proposed capital investments named Project A and Project B. Each project has a cost of 900,000 birr, and the cost of capital (the required rate of return) for each project is 10%. The information on the projects’ expected net cash flows are as follows with the present value of 1 birr at 10%.

Year	Cash flow of the projects in Birr		PV of 1birr at 10%
Year	Project A	Project B	PV of 1birr at 10%
0	- 900,000	- 900,000	1
1	400,000	245,000	0.909
2	350,000	245,000	0.826
3	250,000	245,000	0.751
4	150,000	245,000	0.683
5	100,000	245,000	0.621

Required:

Calculate each project’s payback period (PBP) and determine which project is preferable as per PBP results. (2 pts)
Calculate each project’s net present value (NPV). (2 Pts)
Determine and justify which project or projects should be accepted as per NPV results if they are independent projects. (2Pts).
Determine and justify which project or projects should be accepted as per NPV if they are mutually exclusive projects. (2Pts).
Calculate the internal rate of return (IRR) for each project and determine whether the projects are accepted or rejected as per IRR result and also determine which project is preferable based on IRR. (2Pts)
Discuss the relative strengths and limitations of the capital budgeting decision criteria that you have used above (Payback period, NPV and IRR).( 3Pts)

goldcoyote821

Mr Yaqoob is a financial analyst for M/s Sheeraz & Co. The director of capital budgeting has asked Yaqoob to analyze two proposed capital investments, Projects X and Y. Each project has a cost of Rs. 5,000, and the cost of capital for each project is 10 percent. The projects’ expected net cash flows are as follows:

	Expected Net Cash Flows
Year	Project X	Project Y
0	Rs. (5000)	Rs. (5000)
1	3250	1750
2	1500	1750
3	1500	1750
4	500	1750

Calculate each project’s payback period, net present value (NPV), and internal rate of return (IRR). [3]
Which project or projects should be accepted if they are independent? [0.5]
Which project should be accepted if they are mutually exclusive? [0.5]

d. How might a change in the cost of capital produces a conflict between the NPV and IRR rankings of these two projects?

maroonbeaver539

FINA 2201 Chapter Notes - Chapter 11: Net Present Value, Cash Flow, Capital Budgeting

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