Question

Module 6 Worksheet: Chapter 10 Capital Budgeting – Complete in Excel

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1.        A project has and initial cost of $32,000, expected net cash inflows of $9,500 per year for 7 years, and a cost of capital of 10%.
   1.        What is the project’s NPV?
   2.        What is the project’s IRR?  
   3.        What is the projects payback period?

2.           Your division is considering two investment projects, each of which requires an up-front expenditure of $20 million. You estimate that the investments will produce the following net cash flows:

Year                       Project A              Project B

1                              $5,000,000           $20,000,000

2                              10,000,000           10,000,000

3                              20.000.000           6,000,000

1.        What are the two project’s NPVs assuming the cost of capital is 8%, 14%, 20%?
2.        What are the two projects’ IRRs at those same costs of capital?

Answer 1

Question 1). a). Solution :- NPV of project = Present value of cash inflows - Present value of cash outflows.

Present value of cash inflows = 9500 * Cumulative present value factors for 7 years at 10 % (using present value table)

= 9500 * 4.868 (approx).

= $ 46246.

Present value of cash outflow = $ 32,000 (Given in the question in form of initial cost of project)

Accordingly, NPV of project = 46246 - 32000

= $ 14246.

Question 1). c).Solution :- Payback period of project = Initial cost of project / Annual cash inflow.

= 32000 / 9500

= 3.37 Years (approx).

Question 1). b). Solution :- Calculation of IRR of project :-

For the calculation of internal rate of return, Take two trial discount rates. One discount rate at which the present value of cash inflows are greater than the present value of cash outflows and another discount rate at which the present value of cash inflows are lesser than the present value of cash outflows.

At 10 % Discount rate,

Present value of cash inflows = 9500 * Cumulative present value factors for 7 years at 10 % (using present value table)

= 9500 * 4.868 (approx).

= $ 46246.

At 25 % Discount rate,

Present value of cash inflows = 9500 * Cumulative present value factors for 7 years at 25 % (using present value table)

= 9500 * 3.161 (approx).

= $ 30029.50

Accordingly, Internal rate of return (IRR) lies between 10 % and 25 %. By inter-polation, IRR is calculated as follows :-

= 10 + (25 - 10) * (46246 - 32000) / (46246 - 30029.50)

= 10 + 15 * 14246 / 16216.50

= 10 + 15 * 0.878 (approx)

= 10 + 13.17 (approx)

= 23.17 % (approx)

Conclusion :- Q. 1). a). NPV of project = $ 14246.

Q. 1). b). Internal rate of return (IRR) of project = 23.17 % (approx).

Q. 1). c). Payback period of project = 3.37 Years (approx).