Question

Problem 10-10
Capital Budgeting Methods

Project S has a cost of $11,000 and is expected to produce benefits (cash flows) of $3,400 per year for 5 years. Project L costs $23,000 and is expected to produce cash flows of $6,900 per year for 5 years.

1. Calculate the two projects' NPVs, assuming a cost of capital of 14%. Round your answers to the nearest cent.

   Project S	$
   Project L	$

   Which project would be selected, assuming they are mutually exclusive?
   -Select-Project SProject LItem 3

2. Calculate the two projects' IRRs. Round your answers to two decimal places.

   Project S	%
   Project L	%

   Which project would be selected, assuming they are mutually exclusive?
   -Select-Project SProject LItem 6

3. Calculate the two projects' MIRRs, assuming a cost of capital of 14%. Round your answers to two decimal places.

   Project S	%
   Project L	%

   Which project would be selected, assuming they are mutually exclusive?
   -Select-Project SProject LItem 9

4. Calculate the two projects' PIs, assuming a cost of capital of 14%. Round your answers to two decimal places.

   Project S
   Project L

   Which project would be selected, assuming they are mutually exclusive?
   -Select-Project SProject LItem 12

   Which project should actually be selected?
   -Select-Project SProject LItem 13

Answer 1

a )

Project S : - NPV

NPV = Cash flow / ( 1 +r )¹ + Cash flow / ( 1 +r )² +Cash flow / ( 1 +r )³ - Initial investment

= 3400 / ( 1.14)¹ + 3400 / ( 1.14)² +3400 / ( 1.14)³ +3400 / ( 1.14)⁴​​​​​​​ +3400 / ( 1.14)⁵​​​​​​​ - 11000

= 2982.45 +2616.18 +2294.90 +2013.07 +1765.85 - 11000

=11672.48 - 11000

= $ 672.48

Project L :

NPV =  6900 / ( 1.14)¹ + 6900 / ( 1.14)²​​​​​​​ +6900 / ( 1.14)³​​​​​​​ +6900 / ( 1.14)⁴​​​​​​​ +6900 / ( 1.14)⁵​​​​​​​ - 23000

= 6052.63 + 5309.32 + 4657.30 +4085.35 +3583.64 - 23000

= 23688.26 - 23000

= $ 688.26

Project L have higher NPV . so it should be selected

b )

IRR Project S = 16.52%

IRR Project l = 15.24 %

Here Project S have higher IRR than Project L. so it should be selected

c )

MIRR Project S = 15.36 %

MIRR Project L = 14.67%

Project S have higher MIRR than Project L. so Project S should be select

d )

Profitability index = Present value of cash inflow / initial investment

Project S

Present value of cash inflow = 11672.48

Initial invetsment = 11000

Profitability index = 11672.48 / 11000

= 1.076

Project L

Present value of cash inflow = 23688.26

Initial invetsment = 23000

Profitability index = 23688.26 / 23000

= 1.02

When they are mutually exclusive Higher PI should be select. here Project S have higher profitability index.so it should be selected

in general rule any profitability index results more than 1 should be selected. here both projects PI values are higher than 1.so both projects are selected