Question

4. Capital Budgeting

Suppose you are analyzing a potential project for your small business. It will cost you $75,000 now to purchase all the assets necessary, and you expect the project to yield $25,000 in year one, $35,000 in year 2, and $45,000 in year 3. The cost of capital for this project is 6.0%.

a. What are the project's cash flows? CF0= CF1= CF2= . CF3=

b. What is the project’s net present value (NPV)?

c. What is the project’s IRR?

d. Should you go ahead with the project? Why, or why not?

Answer 1

a.CF0= $75,000

CF1= $25,000

CF2= $35,000

CF3= $45,000

b.Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$75,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the cost of capital of 6%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 6% cost of capital is $17,517.65.

c.Internal rate of return can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$75,000. The initial cash flow is indicated by a negative sign since it is a cash outflow.  
• Cash flow for each of the fifteen years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project is 17.02%.

d.I would go ahead with the project since it generates a positive net present value.