For Week 6, please turn in the answers to the following questions:

1. List the three steps that make up the general approach to capital budgeting.

2. Define an Incremental cash flow as the term is used in capital budgeting

3. Define the payback period method in capital budgeting and state the payback period decision rule.

4. What is the payback period of the following project?

Initial Investment: $60,000

Projected life: 7 years

Net cash flows each year: $14,000

5. Define the discounted payback period method in capital budgeting and state the payback period decision rule.

6. What is the discounted payback period of the project in Question 4, assuming your cost of capital is 7%?

7. Define the Net present Value (NPV) method in capital budgeting and state the NPV decision rule. In economic terms, what does the NPV amount represent?

8. Your firm is looking at a new investment opportunity, Project Z, with net cash flows as follows:

---- Net Cash Flows ----

Project Z

Initial Cost at T-0 (Now) ($100,000)

cash inflow at the end of year 1 50,000

cash inflow at the end of year 2 40,000

cash inflow at the end of year 3 30,000

Calculate project Z's Net Present Value (NPV), assuming your firms required rate of return is 8%.

9. What is a profitability index (PI) as the term is used in capital budgeting?

10. What is the Profitability Index of project Z in question 8?

11. Consider Project Z and another Project, Project N, with net cash flows as follows:

---- Net Cash Flows ----

Project Z Project N

Initial Cost at T-0 (Now) ($100,000) ($200,000)

cash inflow at the end of year 1 50,000 30,000

cash inflow at the end of year 2 40,000 80,000

cash inflow at the end of year 3 30,000 130,000

a. Construct NPV Profiles for these two projects.

b. If the two projects were mutually exclusive, which would you accept if your firms cost of capital were 5%? Which would you accept if your firms cost of capital were 10%?

12. Define the Internal Rate of Return (IRR) method in capital budgeting and state the IRR Decision rule.

13. Calculate the IRR of the following project:

Year Cash Flow

0 ($350,000)

1 $150,000

2 $140,000

3 $130,000

14. Calculate the Modified Internal Rate of Return (MIRR) of the project in Question 13, assuming your firms cost of capital is 7%.

End of assignment questions

(see answers to numerical problems below)

Answers to numerical problems:

Question 4: Sometime in the 5^th year

Question 6: Sometime in the 6^th year

Question 8: $4,405

Question 10: 1.044

Question 13: 10.0%

Question 14: 8.9%