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Capital Budgeting and Financial Analysis Techniques: A Comprehensive Study

A comprehensive study of capital budgeting and financial analysis techniques.

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    Capital Budgeting and Financial Analysis Techniques: A Comprehensive Study, page 1Capital Budgeting and Financial Analysis Techniques: A ComprehensiveStudyProblem Set 4In all problems, show your work and label your answers.1.Time012345Project A−3,0001,0001,2001,400200200Assume that this company has a 10%cost of capital. Then compute:a. Paybackb. Discounted or Present Value Paybackc. NPVd. IRRAnswer:•Payback Period: 2.57 years•Discounted Payback Period: 3.35 years•NPV: 213.50•IRR: 15.2%2.Time01234Cash Flow220−200−200−200400The investment has two IRRs. The first is at7% and the second is approximately 34%.Draw the NPV profile of this investment and describe the cost of capital that would make thisinvestment acceptable.Answer:

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    Capital Budgeting and Financial Analysis Techniques: A Comprehensive Study, page 2

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    Capital Budgeting and Financial Analysis Techniques: A Comprehensive Study, page 3The investment is acceptable when the cost of capital isless than 7%, as the NPV is positive.Between7% and 34%, it's not acceptable (NPV is negative). The NPV profile has two IRRs:7%and34%.3.Time0123Project X−1,000650650Project Y−1,000470470470a.Assuming a 10% cost of capital, compute the NPV of these two investments.b.If we were planning on replacing the two investments in the future, can you rely on theNPV that you computed in part a? Explain.No, you cannot fully rely on the NPV computed in part (a) if you're planning to replace theprojects in the future. This is because the NPV assumes a single life cycle and doesn't accountfor the possibility of future replacement costs or changes in cash flows. For projects with long-term horizons or replacement strategies, a more sophisticated method likereplacement analysisorequivalent annual costshould be used.c.Compute the equivalent annual annuities for these two investments.

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