4. Capital Budgeting Suppose you are analyzing a potential project for your small business. It will...

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?

Solutions

Expert Solution

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.

jeff jeffy answered 1 year ago

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