Question 1

A company has two projects to choose from with the following annual after-tax cash flows:

Project X

Investment (today)$800,000

Investment (Year 1) $500,000

Years 25$750,000

Project Y

Investment (today)$1,800,000

Years 15$950,000

The firm's cost of capital is 12 percent.

Compute both projects' payback period and discounted payback period.(4 marks)

Question 2

The R.M. Company uses the following risk-adjusted discount rates for capital budgeting purposes:

Investments in new product lines15%

Substitution of labour with capital (machinery)11%

Expansion of existing product lines13%

Replacement of existing equipment9%

The firm has $1,000,000 of available capital for investment.Project X involves the production of a brand new product line.Project Y involves the replacement of existing machinery.Project Z involves the purchase of a more sophisticated piece of equipment as a replacement for existing machinery.This more sophisticated machine will enable R.M. Company to reduce the size of its workforce.There are no other projects available at this time.

Expected cash flows for these independent projects are as follows:

Projects

XYZ

(in thousands of dollars)

Investment (today)8001,000200

Net after-tax cash inflows

Year 132026060

Year 230030080

Year 3280360100

Year 4260420120

Which project(s) would you recommend the company undertake?Show your calculations and provide any necessary explanations.(4 marks)

Question 3

A company has $40 million available to invest in new projects.There are three independent projects that it is considering.The after-tax cash flows of the projects are as follows:

ProjectInvestment (today)Year 1 cash flowYear 2 cash flow

X40 million40 million20 million

Y20 million16 million14 million

Z20 million12 million20 million

Calculate the IRR, PI and NPV of each of the two-year projects and recommend which project(s) the company should invest in (and why).The company's cost of capital is 12%.(4 marks)