Answer " 3c" ONLY AND SHOW FULL WORK with EXPLANATION!! Thank you

3. (40 points) capital budgeting , time value of money

You are given with the following information of two projects planned by your company. Each cash flow per year shown in Table 1 represents the cash flow at the end of each year during the project. For instance, for project A, the cash flow as 613 in first year is expected at the end of the Year 1. The initial outlays for the projects are paid out by installments with regular payments as 0.89 million at the beginning of each year for project 1 and $0.91 million per beginning of each year for project 2, respectively.

Table 1: (in thousands)

ProjectYear 1Year 2Year3Year4Year5

A7342002152023172019

B63831092540

Answer the following questions.

a)Suppose the cost of capital (or so-called discount rate) is 12%, what is the Net Present Value for each project? Which project would you prefer? Why?

The solutions attached below on IRR and NPV are based on the assumption that the figures in the given table are in 000's. The figures given in our table are not very clear thus I decided to go with that assumption in regard to the cash outlays. Professor Jeng, if I misunderstood, please just adjust the figures within the original table in the excel spreadsheet and my answer should be correct either way.

Project A = $2,647,767.51

Project B = $2,572,874.00

Decision:

Based on the purely the NPV criterion, then we would chose Project A since it has a higher NPV. However, the projects have unequal time periods and this decision would be wrong. To further aid on the decision we would need to carry out a replacement chain method or calculate an equivalent annuity cash flow (EAC) for the two project. I've reseach and found how to do this online through different examples.

Carry a replacement chain method, the NPV of project B is higher than that of Project A for the equal time period (5). Therefore, Project B is preferred and is the best to invest in.

The EAC confirms that that Project B is the most preferred producing a cash flow that his higher.

b) What are the pros and cons in using the NPV decision rule for the capital budgeting?

The pros of using the NPV decision rule are that it is easier to calculate and optimality is taken into account. The cons are that it generally accepts the longer projects, all future cash flows are additive, and the discount rate is the same for all cash flows across different time frames.

c)Let the corporate income tax rate be 30%, the cost of debts (that is, the interest rate) be 6.5%, the cost of equity be 28% and there is no preferred stock issued by the firm. Assuming the weighted average cost of capital is given as 12% in a),what is the debt-to-equity ratio for your company?