Capital Budgeting Analysis

Solve the following problems. Create appropriate formulas using the supplied values in the corresponding cells so Excel can calculate the answer. Example problems can be found on the “Capital Budgeting Example” tab below. Compute the NPV statistic for Project Y. Explain whether or not the firm should accept or reject the project with the cash flows shown in the chart below if the appropriate cost of capital is 10 percent.Year Cash Flow0 -$8,0001 $3,3502 $4,1803 $1,5204 $300 NPV= [NPV Calc. here][Brief Explanation] Compute the payback period statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown in the chart if the maximum allowable payback is four years.Year Cash Flow0 -$1,4501 $2502 $3803 $6204 $1,0005 $100Payback period = [Answer here] Two projects being considered are mutually exclusive and have the following projected cash flows: (Compute both NPV and IRR). The cost of capital is 10%.Year Cash Flow A Cash Flow B0 -$50,000 -$50,0001 $15,625 $02 $15,625 $03 $15,625 $04 $15,625 $05 $15,625 $99,500 NPV = [Answer here] [Answer here]IRR = [Answer here] [Answer here] Los Angeles Lumber Company is considering a project with a cost of $1,000 initially, and inflows of $300 at the end of years 1-5. LALC’s cost of capital is 12 percent. What is the project’s IRR and NPV? IRR NPV A Project has a cost of $65,000 and it’s expected cash inflows are $12,000 per year for 9 years and the cost of capital is 10%. What is the project’s IRR and MIRR? IRR MIRR Explain which capital budgeting method is better, NPV, IRR or MIRR. [Answer here] Share on Facebook Tweet Follow us Sample Answer   Capital Budgeting Analysis Capital budgeting involves evaluating and selecting long-term investment projects based on their potential profitability. In this analysis, we will compute various financial metrics for different projects to determine their viability. 1. Project Y NPV Calculation and Decision Given cash flows for Project Y: Year Cash Flow 0 -$8,000 1 $3,350 2 $4,180 3 $1,520 4 $300 NPV Formula: NPV = Σ(CFt / (1 + r)^t) – Initial Investment NPV Calculation: NPV = -8000 + 3350/(1+0.10)^1 + 4180/(1+0.10)^2 + 1520/(1+0.10)^3 + 300/(1+0.10)^4 Decision: If NPV > 0, accept the project; if NPV < 0, reject the project. 2. Project X Payback Period Calculation and Decision Given cash flows for Project X: Year Cash Flow 0 -$1,450 1 $250 2 $380 3 $620 4 $1,000 5 $100 Payback Period Formula: Payback Period = Number of years before cumulative cash inflows ≥ Initial Investment Payback Period Calculation: Identify the year at which cumulative cash inflows equal or exceed the initial investment. Decision: If the payback period is less than the maximum allowable payback period, accept the project; otherwise, reject it. 3. NPV and IRR for Mutually Exclusive Projects A and B Given cash flows for Projects A and B: Year Cash Flow A Cash Flow B 0 -$50,000 -$50,000 1 $15,625 $0 2 $15,625 $0 3 $15,625 $0 4 $15,625 $0 5 $15,625 $99,500 NPV Formula: NPV = Σ(CFt / (1 + r)^t) – Initial Investment IRR Formula: IRR is the discount rate that makes NPV equal to zero. Decision: Compare the NPV values for both projects to determine the most profitable option. Select the project with the higher NPV or IRR. 4. Los Angeles Lumber Company Project Analysis Given inflows for LALC project: Initial Cost: $1,000 Cash Inflows: $300 per year for years 1-5 Cost of Capital: 12% IRR Calculation: Find the discount rate that makes the project’s NPV equal to zero. NPV Calculation: Calculate NPV using the formula and compare it with zero to determine project viability. 5. Project with Expected Cash Inflows Given project information: Cost: $65,000 Cash Inflows: $12,000 per year for 9 years Cost of Capital: 10% IRR Calculation: Compute IRR to determine the project’s rate of return. MIRR Calculation: Calculate MIRR to account for reinvestment rates and provide a more accurate representation of profitability. 6. Comparison of Capital Budgeting Methods – NPV: Considers the absolute value of cash flows and provides a dollar amount of profitability. – IRR: Focuses on the rate of return and is useful for comparing projects against a required rate of return. – MIRR: Considers both the cost of capital and reinvestment rate, providing a more accurate picture of project profitability over time. In conclusion, NPV is generally considered the superior capital budgeting method as it accounts for both the timing and magnitude of cash flows, making it a more reliable indicator of a project’s profitability. IRR can be a good supplementary metric for decision-making, while MIRR offers a better reflection of true project returns when compared to IRR.       This question has been answered. Get Answer


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