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Morton Property Ltd requests you to evaluate two new capital budgeting proposals and provide your recommendations. You are required to submit a report responding to

Morton Property Ltd requests you to evaluate two new capital budgeting proposals and provide your recommendations. You are required to submit a report responding to the underlisted questions.

Instructions are as follows:

Provide an evaluation of two proposed projects, both with identical initial outlay of $400,000. The required rate of return on both projects is set at 15%. The expected after-tax cash flows from each project are as presented in the table below.

PROJECT A

PROJECT B

Inflow year 1

$90,000

$180,000

Inflow year 2

$160,000

$180,000

Inflow year 3

$150,000

$180,000

Inflow year 4

$180,000

$180,000

Inflow year 5

$80,000

$180,000

Inflow year 6

$180,000

1

In evaluating these projects, please respond to the following questions:

  1. Distinguish between required rate of return and internal rate of return (IRR). (5 marks)
  2. Determine the net present value (NPV) of both projects. Should the projects be accepted? Explain in detail, including all calculations. (10 marks)
  3. Determine the IRR for each of each project. Should the projects be accepted? Explain in detail, including all calculations. (10 marks)
  4. Would your conclusions in parts (2) and (3) change if the required rate of return decreased to 12%? Explain in detail, including all calculations. [15 marks]
  5. Under what circumstances will the NPV and IRR offer different recommendations, and which recommendation is preferred? Carefully explain (10 marks)
  6. Determine the profitability index for each of these projects? Should the projects be accepted? Explain. (5 marks)
  7. Define payback period. What is the payback period on each project? If Progress Property Ltd imposes a 3-year maximum acceptable payback period, which of these projects should be accepted? (10 marks)
  8. What are the main limitations of the pay back method of capital budgeting? Despite these limitations most chief financial officers (CFOs) use it. Explain why. (5 marks)

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