Question

(b) Company X is currently making its capital budgeting decisions for the upcoming
year. Among the projects they are considering, are two equipment: Equipment A
and equipment AA. Equipment A costs $50,000 but will produce expected
after-tax cash inflows of $30,000 at the end of each of the next 2 years.
Equipment AA also costs $50,000 but will produce expected after tax cash
inflows of $16,500 at the end of each of the next 4 years. Both projects have a
12% cost of capital.Assume that these are Mutual excusive projects. Using NPV,
Which project or projects should the company accept? [5]

(c) year CFX
0 (50,000)
1 20,850
2 20,850
3 20,850
4 20,850
It is now determined that the cost of capital for both projects is 14%.
Using IRR, should the Project be selected? [6]

(d) What are two (2) disadvantages of the Payback Period?

Answer 1

b

EquiPment A
Discount rate	12.000%
Year	0	1	2
Cash flow stream	-50000	30000	30000
Discounting factor	1.000	1.120	1.254
Discounted cash flows project	-50000.000	26785.714	23915.816
NPV = Sum of discounted cash flows
NPV Equitment A =	701.53
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Equipment AA
Discount rate	12.000%
Year	0	1	2	3	4
Cash flow stream	-50000	16500	16500	16500	16500
Discounting factor	1.000	1.120	1.254	1.405	1.574
Discounted cash flows project	-50000.000	14732.143	13153.699	11744.374	10486.048
NPV = Sum of discounted cash flows
NPV Equipment AA =	116.26
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Accept equipment A as it has higher NPV

c

Project
IRR is the rate at which NPV =0
IRR	24.14%
Year	0	1	2	3	4
Cash flow stream	-50000.000	20850.000	20850.000	20850.000	20850.000
Discounting factor	1.000	1.241	1.541	1.913	2.375
Discounted cash flows project	-50000.000	16795.107	13528.807	10897.735	8778.351
NPV = Sum of discounted cash flows
NPV Project =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

Accept project as IRR is more than cost of capital of 14%

d

Doesnot take account of time value of money

Does not take account of cash flows after the payback period