Question
The director of capital budgeting has asked you to analyze two proposed capital investments, Projects X and Y. Each project has a cost of Rs.
The director of capital budgeting has asked you to analyze two proposed capital investments, Projects X and Y. Each project has a cost of Rs. 10,000, and the cost of capital for each project is 12 percent. The projects' expected net cash flows are as follows:
Year Expected Net Cash Flows
Project X Project Y
0 Rs. (10,000) Rs. (10,000)
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500
a) Calculate each project's payback period, net present value (NPV), and internal rate of return (IRR).
b) Which project or projects should be accepted if they are independent?
c) Which projects should be accepted if they are mutually exclusive?
2 of 3
d) How might a change in the cost of capital produces a conflict between the NPV and IRR rankings of these two projects? Would this conflict exist if the cost of capital were 5 percent?
(Hint: Plot the NPV profiles.)
e) Why does the conflict exist?
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