Mini Case. Chapter 10 (similar to) Your first assignment in your new position as assistant financial analyst at Caledonia Products is to evaluate two new capital-budgeting proposals. Because this is your first assignment, you have been asked not only to provide a recommendation but also to respond to a number of questions aimed at assessing your understanding of the capital-budgeting process. This is a standard procedure for all new financial analysts at Caledonia, and it will serve to determine whether you are moved directly into the capital-budgeting analysis department or are provided with remedial training. The memorandum you received outlining your assignment follows: To: New Financial Analysts From: Mr. V. Morrison, CEO, Caledonia Products Re: Capital-Budgeting Analysis Provide an evaluation of two proposed projects, both with 5-year expected lives and identical initial outlays of $110,000. Both of these projects involve additions to Caledonia's highly successful Avalon product line, and as a result, the required rate of return on both projects has been established at 15 percent. The expected free cash flows from each project are shown in the popup window: n evaluating these projects, please respond to the following questions: a. Why is the capital-budgeting process so important? cash outlays at the beginning of the life of the project and commit the firm a. The capital-budgeting process is so important because capital-budgeting decisions involve investments requiring rather time horizon. (Select from the drop-down menus.) to a particular course of action over a relatively Mini Case. Chapter 10 (similar to) In evaluating these projects, please respond to the following questions: a. Why is the capital-budgeting process so important? Why is it difficult to find exceptionally profitable projects? c. What is the payback period on each project? If Caledonia imposes a 4-year maximum acceptable payback period, which of these projects should be accepted? d. What are the criticisms of the payback period? e. Determine the NPV for each of these projects. Should either project be accepted? f. Describe the logic behind the NPV g. Determine the Pl for each of these projects. Should either project be accepted? h. Would you expect the NPV and Pl methods to give consistent accept/reject decisions? Why or why not? i.What would happen to the NPV and PI for each project if the required rate of return increased? If the required rate of return decreased? j. Determine the IRR for each project. Should either project be accepted? k. How does a change in the required rate of return affect the project's internal rate of return? I. What reinvestment rate assumptions are implicitly made by the NPV and IRR methods? Which one is better? Data Table a. The capital-budgeting process is so important because capital-budgeting decisions involve investments requ time horizon. (Select from the drop-down menu to a particular course of action over a relatively PROJECT A PROJECT B Initial outlay -$110,000 -$110,000 40,000 40,000 Inflow year 1 Inflow year 2 10,000 30,000 50,000 40,000 40,000 Inflow year 3 Inflow year 4 40,000 Inflow year 5 70,000 40,000 Click select your answer(s) and then click Check
