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Capital Budgeting Assignment For the following two projects, determine the Payback Period Discounted Payback Net Present...
Capital Budgeting Assignment
For the following two projects, determine the
- Payback Period
- Discounted Payback
- Net Present Value
- Profitability Index (Benefit-Cost Ratio)
- Internal Rate of Return
- Modified Internal Rate of Return
|
|
Project A |
Project B |
||||
|
Year |
Net Income |
Cash Flow |
Net Income |
Cash Flow |
||
|
0 |
(15,000) |
(19,000) |
||||
|
1 |
5,000 |
6,000 |
3,000 |
4,000 |
||
|
2 |
5,000 |
6,000 |
5,000 |
6,000 |
||
|
3 |
5000 |
6,000 |
7,000 |
8,000 |
||
|
4 |
5,000 |
6,000 |
11,000 |
12,000 |
||
|
Risk Index |
1.80 |
.60 |
The firm’s cost of capital ko is 15% and the risk free rate Rf is 10%. The firm assesses risk and assigns a risk index to determine a risk adjusted discount rate. An index of 1.0 would be assigned to an average risk project.
To determine risk adjusted rates the firm uses the following equation:
Risk Adjusted Rate (RADR) = Rf + [Risk Index (ko – Rf)
Task: Rank the projects in accordance with each method of analysis.
Solutions
Expert Solution
| PROJECT A:: | |||||||||||||
| Risk adjusted discount rate = 10%+1.80*(15%-10%) = | 19.00% | ||||||||||||
| Year | Cash flow | Cumulative cash flow | PVIF at 19% | PV at 19% | Cumulative PV | PVIF at 22% | PV at 22% | PVIF at 21% | PV at 21% | FVIF at 19% | FV at 19% | ||
| 0 | -15000 | -15000 | 1 | -15000 | -15000 | 1.0000 | -15000 | 1.00000 | -15000 | ||||
| 1 | 6000 | -9000 | 0.84034 | 5042 | -9958 | 0.8197 | 4918 | 0.82645 | 4959 | 1.68516 | 10111 | ||
| 2 | 6000 | -3000 | 0.70616 | 4237 | -5721 | 0.6719 | 4031 | 0.68301 | 4098 | 1.41610 | 8497 | ||
| 3 | 6000 | 3000 | 0.59342 | 3560 | -2160 | 0.5507 | 3304 | 0.56447 | 3387 | 1.19000 | 7140 | ||
| 4 | 6000 | 9000 | 0.49867 | 2992 | 832 | 0.4514 | 2708 | 0.46651 | 2799 | 1.00000 | 6000 | ||
| 832 | -38 | 243 | 31748 | ||||||||||
| Payback period = 2+3000/6000 = | 2.50 | Years | |||||||||||
| Discounted payback = 3+2160/2992 = | 3.72 | Years | |||||||||||
| NPV | 832 | ||||||||||||
| PI = 15832/15000 = | 1.06 | ||||||||||||
| IRR = 21%+1%*243/(243+38) = | 21.86% | ||||||||||||
| MIRR = (31748/15000)^(1/4)-1 = | 20.62% | ||||||||||||
| PROJECT B:: | |||||||||||||
| Risk adjusted discount rate = 10%+0.6*(15%-10%) = | 13.00% | ||||||||||||
| Year | Cash flow | Cumulative cash flow | PVIF at 13% | PV at 13% | Cumulative PV | PVIF at 18% | PV at 18% | PVIF at 17% | PV at 17% | FVIF at 13% | FV at 13% | ||
| 0 | -19000 | -19000 | 1 | -19000 | -19000 | 1.0000 | -19000 | 1.00000 | -19000 | ||||
| 1 | 4000 | -15000 | 0.88496 | 3540 | -15460 | 0.8475 | 3390 | 0.85470 | 3419 | 1.44290 | 5772 | ||
| 2 | 6000 | -9000 | 0.78315 | 4699 | -10761 | 0.7182 | 4309 | 0.73051 | 4383 | 1.27690 | 7661 | ||
| 3 | 8000 | -1000 | 0.69305 | 5544 | -5217 | 0.6086 | 4869 | 0.62437 | 4995 | 1.13000 | 9040 | ||
| 4 | 12000 | 11000 | 0.61332 | 7360 | 2143 | 0.5158 | 6189 | 0.53365 | 6404 | 1.00000 | 12000 | ||
| 2143 | -243 | 201 | 34473 | ||||||||||
| Payback period = 3+1000/12000 = | 3.08 | Years | |||||||||||
| Discounted payback = 3+5217/7360 = | 3.71 | Years | |||||||||||
| NPV | 2143 | ||||||||||||
| PI = 15832/15000 = | 1.06 | ||||||||||||
| IRR = 17%+1%*201/(201+243) = | 17.45% | ||||||||||||
| MIRR = (34473/19000)^(1/4)-1 = | 16.06% | ||||||||||||
| RANKING: | |||||||||||||
| Project A | Project B |
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