Capital Budgeting Practice Problems a. Consider the project with the following expected cash flows: Year Cash flow 0 -$400,000 1 $100,000 2 $120,000 3 $850,000 If the discount rate is 0%, what is the project's net present value? If the discount rate is 2%, what is the project's net present value? If the discount rate is 6%, what is the project's net present value? If the discount rate is 11%, what is the project's net present value? With a cost of capital of 5%, what is this project's modified internal rate of return? Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the "x" axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. connect the four points using a free hand 'smooth' curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis? [ Look at the graph you draw and write a short paragraph stating what the graph 'shows"].. b. Consider a project with the expected cash flows: Year Cash flow 0 -$815,000 1 $141,000 2 $320,000 3 $440,000 What is this project's internal rate of return? If the discount rate is 1%, what is this project's net present value? If the discount rate is 4%, what is this project's net present value? If the discount rate is 10%, what is this project's net present value? If the discount rate is 18%, what is this project's net present value? Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the "x" axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. connect the four points using a free hand 'smooth' curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis? [ Observe the graph and write a short paragraph stating what the graph 'shows] c. A project requiring a $4.2 million investment has a profitability index of 0.94. What is its net present value? (Remember: Profitability Index is defined as Present Value of the proceeds divided by the initial investment) Part 2. Read the article below. Then write a one-to-two page paper answering the following question: Which method do you think is the better one for making capital budgeting decisions - IRR or NPV? Defend your answer with references to the background materials. Please read the following article which is available in Proquest: Internal rate of return Computerworld. Framingham, Feb 17, 2003, Gary H Anthes. Abstract: Internal rate of return (IRR) is the flip side of net present value (NPV) and is based on the same principles and the same math. NPV shows the value of a stream of future cash flows discounted back to the present by some percentage that represents the minimum desired rate of return, often a company's cost of capital. IRR, on the other hand, computes a break-even rate of return. It shows the discount rate below which an investment results in a positive NPV and above which an investment results in a negative NPV. It is the breakeven discount rate, the rate at which the value of cash outflows equals the value of cash inflows