Capital Budgeting Techniques

1. Determine the IRR of the following.(Hint:If you use the financial calculator app, there is an IRR and NPV calculator option).

A) Define IRR. Provide an example of how companies may use it.

B) An initial investment of $10,750 resulting in a free cash flow of $3,500 at the end of year 1, $2,000 at the end of year 2, and $7,000 at the end of year 3.

C) An initial investment of $5,000 resulting in a SINGLE free cash flow of $38,077 after 10 years.

D) An initial investment of $12,000 resulting in a free cash flowof $7,000 at the end of year 1 through 5 and $8,000 at the end of year 6.

2. You have recently won some money playing bingo and are in a dilemma of what you do with the money.Being the savvy finance person that you are, you decide to invest. You begin to are consider a project with an initial cash outlay of $80,000 and expected cash flows of $20,000 at the end of each year for 6 years. The required rate of return for each project is 10 percent.

A) What is the projects payback period?

B) What is the project's NPV?

C) What is the project's PI?

D) What is the project's IRR?

3.You are the owner of an investment firm, You Corp. To increase profits you beginconsidering seven capital investment proposals but are limited to a maximum of$12 million. The projects are independent and have the following costs and profitability indexes associated with them:

ProjectCostIndexCash FlowsNPV

A$4,000,0001.18$4,720,000$ 720,000

B3,000,000 1.083,240,000240,000

C5,000,000 1.336,650,0001,650,000

D6,000,000 1.317,860,0001,860,000

E4,000,000 1.194,760,000760,000

F6,000,000 1.207,200,0001,200,000

G4,000,000 1.184,720,000720,000

A) Under strict capital rationing, what projects should you select? Why?

4.You Corp, is analyzing two mutually exclusive projects. The free cash flows associated with these projects are as follows.

Year Cash Flows Cash Flows

0 -50,000 -50,000

1 15,625 0

2 15,625 0

3 15,625 0

4 15,625 0

5 15,625 100,000

The required rate of return on these projects is 10%

A) What s each project's payback period?

B) What is each project's NPV?

C) What is each project's IRR?

D) Which project should be accepted? Why?

Cash Flows and Other Topics

5.Why do we focus on cash flows rather than accounting profits in making our capital-budgeting decisions?

6. What is a sunk cost? How do sunk costs affect the determination of cash flows associated with an investment proposal?

7. You are the leading manager in a project thatwill generate revenues of$250,000 annually. The fixed and variable costs for the year are $140,000. Depreciation will be $15,000 a your company operates on the 34% tax bracket.Calculate the operating cash flows.

8. You Corp., just introduced a brand new product. The product has an EBIT of $500,000 and the company has a 40 percent marginal tax rate. The product will produce $95,000 in depreciation a year and has the following changes.

With the Project Without the Project

Accounts Receivable$40,000 $73,000

Inventory $60,000 $81,000

Accounts Payable$71,000 $89,000

What is the project's free cash flow in year 1?

9.You are leading new project that will generate $1.5 million of revenue. Cash expenses including both fixed and variable costs will be $500,000 and depreciation will increase by $50,000 a year. In addition, let's assume the firm's marginal tax rate is 34%. Calculate the operating cash flows.

10. From the information below: Determine each project's risk adjusted net present value.

Project AProject B

Initial outlay (10,000) (10,000)

Year 1 5,000 6,000

Year 2 5,000 6,000

Year 3 5,000 6,000

Year 4 5,000 6,000

Year 5 5,000 6,000

Required Rate of Return for project A:12%

Required Rate of Return for project B:15%