Question

CAPITAL BUDGETING CRITERIA

A firm with a 14% WACC is evaluating two projects for this year's capital budget. After-tax cash flows, including depreciation, are as follows:

0

1

2

3

4

5

Project M	-$18,000	$6,000	$6,000	$6,000	$6,000	$6,000
Project N	-$54,000	$16,800	$16,800	$16,800	$16,800	$16,800

1. Calculate NPV for each project. Round your answers to the nearest cent. Do not round your intermediate calculations.
   Project M    $
   Project N    $

   Calculate IRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
   Project M      %
   Project N      %

   Calculate MIRR for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
   Project M      %
   Project N      %

   Calculate payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
   Project M      years
   Project N      years

   Calculate discounted payback for each project. Round your answers to two decimal places. Do not round your intermediate calculations.
   Project M      years
   Project N      years

2. Assuming the projects are independent, which one(s) would you recommend?
   -Select-Only Project M would be accepted because IRR(M) > IRR(N).Both projects would be rejected since both of their NPV's are negative.Only Project M would be accepted because NPV(M) > NPV(N).Only Project N would be accepted because NPV(N) > NPV(M).Both projects would be accepted since both of their NPV's are positive.Item 11
3. If the projects are mutually exclusive, which would you recommend?
   -Select-If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project N.If the projects are mutually exclusive, the project with the highest positive NPV is chosen. Accept Project N.If the projects are mutually exclusive, the project with the highest positive IRR is chosen. Accept Project M.If the projects are mutually exclusive, the project with the highest positive MIRR is chosen. Accept Project M.If the projects are mutually exclusive, the project with the shortest Payback Period is chosen. Accept Project M.Item 12
4. Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?
   -Select-There is no conflict between NPV and IRR.The conflict between NPV and IRR occurs due to the difference in the size of the projects.The conflict between NPV and IRR is due to the relatively high discount rate.The conflict between NPV and IRR is due to the fact that the cash flows are in the form of an annuity.The conflict between NPV and IRR is due to the difference in the timing of the cash flows.Item 13

Answer 1

Project M
Discount rate	0.14
Year	0	1	2	3	4	5
Cash flow stream	-18000	6000	6000	6000	6000	6000
Discounting factor	1	1.14	1.2996	1.481544	1.6889602	1.925415
Discounted cash flows project	-18000	5263.158	4616.805	4049.829	3552.4817	3116.212
NPV = Sum of discounted cash flows
NPV Project M =	2598.49
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Project N
Discount rate	0.14
Year	0	1	2	3	4	5
Cash flow stream	-54000	16800	16800	16800	16800	16800
Discounting factor	1	1.14	1.2996	1.481544	1.6889602	1.925415
Discounted cash flows project	-54000	14736.84	12927.05	11339.52	9946.9487	8725.394
NPV = Sum of discounted cash flows
NPV Project N =	3675.76
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Project M
IRR is the rate at which NPV =0
IRR	0.198577097
Year	0	1	2	3	4	5
Cash flow stream	-18000	6000	6000	6000	6000	6000
Discounting factor	1	1.198577	1.436587	1.72186	2.0637824	2.473602
Discounted cash flows project	-18000	5005.936	4176.566	3484.603	2907.2833	2425.612
NPV = Sum of discounted cash flows
NPV Project M =	3.1177E-05
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	19.86%
Project N
IRR is the rate at which NPV =0
IRR	0.167976214
Year	0	1	2	3	4	5
Cash flow stream	-54000	16800	16800	16800	16800	16800
Discounting factor	1	1.167976	1.364168	1.593316	1.8609555	2.173552
Discounted cash flows project	-54000	14383.85	12315.19	10544.05	9027.6204	7729.284
NPV = Sum of discounted cash flows
NPV Project N =	2.29795E-06
Where
Discounting factor =	(1 + IRR)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	16.80%
Project M
Combination approach
All negative cash flows are discounted back to the present and all positive cash flows are compounded out to the end of the project’s life
Thus year 5 modified cash flow=(10133.76)+(8889.26)+(7797.6)+(6840)+(6000)
=39660.62
Thus year 0 modified cash flow=-18000
=-18000
Discount rate	0.14
Year	0	1	2	3	4	5
Cash flow stream	-18000	6000	6000	6000	6000	6000
Discount factor	1	1.14	1.2996	1.481544	1.6889602	1.925415
Compound factor	1	1.68896	1.481544	1.2996	1.14	1
Discounted cash flows	-18000	0	0	0	0	0
Compounded cash flows	-5.55556E-05	10133.76	8889.26	7797.6	6840	6000
Modified cash flow	-18000	0	0	0	0	39660.62
Discounting factor (using MIRR)	1	1.171163	1.371623	1.606394	1.88135	2.203368
Discounted cash flows	-18000	0	0	0	0	18000
NPV = Sum of discounted cash flows
NPV=	5.71936E-05
MIRR is the rate at which NPV = 0
MIRR=	17.12%
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
Compounding factor =	(1 + reinvestment rate)^(time of last CF-Corresponding period in years)
Compounded Cashflow=	Cash flow stream*compounding factor

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