Question

Capital Budgeting

BioMed Engineering is considering two mutually exclusive investments. The projects' expected net cash flows are as follows:                                                                                                      

                                                                                                            

                        Expected Net Cash Flows                                                                                   

            Time     Project A          Project B                                                                       

            0          ($405)                ($705)                                                               

            1          ($285)              $200                                                                 

            2          ($205)              $205                                                                 

            3          ($105)              $210                                                                 

            4          $605                 $215                                                                 

            5          $650                 $220                                                                 

            6          $925                 $225                                                                 

            7          ($200)              $230                                                                 

In your report, identify which project would be selected (assuming they are mutually exclusive) for each investment criterion. Note that cash outflows (costs) are given in parenthesis. Employ the Excel file to answer the following questions.

Part 3: Payback and PI

G. Calculate the cumulative cash flows and the payback for project A. (7 points)

H. Calculate the cumulative cash flows and the payback for project B. (7 points)

I. Calculate the profitability index for project A. Note to exclude the initial cost from the NPV of future cash flows. (7 points)

J. Calculate the profitability index for project B. Note to exclude the initial cost from the NPV of future cash flows. (7 points)

Part 3:

G) Payback Project A

Time period	0	1	2	3	4	5	6	7
Cash flow	-$405.00	-$285.00	-$205.00	-$105.00	$605.00	$650.00	$925.00	-$200.00
Cumulative cash flow
Payback

H) Payback Project B

Time period	0	1	2	3	4	5	6	7
Cash flow	-$705.00	$200.00	$205.00	$210.00	$215.00	$220.00	$225.00	$230.00
Cumulative cash flow
Payback

I) Profitability Index Project A

Cost of capital =	12%
NPV of future cash flows:
Initial cost for A:
PI of A:

J) Profitability Index Project B

Cost of capital =	12%
NPV of future cash flows:
Initial cost for A:
PI of B:

Answer 1

Part 3 G:

Pay back period of project A= 4.61 years

Cumulative Cash Flows and calculation of pay back period as follows:

Part 3 H:

Pay back period of project B= 3.42 years

Cumulative Cash Flows and calculation of pay back period as follows:

Part 3 I:

NPV of future cash flows of project A= $638.85

Initial cost for Project A= $405

Profitability index of project A= NPV of future cash flow/Initial cost= 638.85/405 = 1.5774

Details of calculation as given under part 3G.

Part 3 J:

NPV of future cash flows of project B= $970.97

Initial cost for Project A= $705

Profitability index of project A= NPV of future cash flow/Initial cost= 970.97/705 = 1.3773

Details of calculation as given under part 3H.