chapter ix tutorial
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Chapter IX Tutorial. Capital Budgeting Techniques. Capital Budgeting Techniques. Calculate, interpret, and evaluate the payback period. Calculate, interpret, and evaluate the present value (NPV). Calculate, interpret, and evaluate the internal rate of return (IRR). Exercise 9 - 3. - PowerPoint PPT PresentationTRANSCRIPT
Chapter IXTutorial
Capital Budgeting Techniques
Capital Budgeting Techniques
• Calculate, interpret, and evaluate the payback period.
• Calculate, interpret, and evaluate the present value (NPV).
• Calculate, interpret, and evaluate the internal rate of return (IRR).
Exercise 9 - 3
• Project Kelvin will cost $45,000 and generate cash inflows of $20,000 per year for the next 3 years
• Project Thompson will cost $275,000 and generate cash inflows of $60,000 per year for 6 years.
• Using an 8% cost of capital, calculate each project’s NPV and make a recommendation based on your findings
Exercise 9 - 3 Solution
Exercise 9 - 4
• Calculate the IRR for each of the following projects and recommend best project.
• Project T-shirt requires initial investment of $15,000 and generates cash inflows of $8,000 per year for 4 years.
• Project Board Shorts requires an initial investment of $25,000 and produces cash inflows of $12,000 per year for 5 years.
Exercise 9 - 4 Solution
Project T-Shirt• PV = -15,000• N = 4• PMT = 8,000• Solve for I IRR = 39.08%
Problem 9 - 1
• Payback period• Jordan Enterprises is considering a capital
expenditure that requires an initial investment of $42,000 and returns after-tax inflows of $7,000 per year for 10 years. The firm has maximum acceptable payback period of 8 years.
a) Determine the payback period for this project.b) Should the company accept the project? Why?
Problem 9 - 1 Solution
(a) $42,000 / $7,000 = 6 years(b) The company should accept the
project, since 6 < 8.
Problem 9 - 3
• Choosing between 2 projects with acceptable payback periods
• Each project requires $100,000 investment
• Maximum payback period 4 years
a) Determine payback period of each project.
b) Which one should they choose?
c) Explain why is one of the projects a better choice.
Year Project A Project B1 $10,000 $40,000
2 $20,000 $30,000
3 $30,000 $20,000
4 $40,000 $10,000
5 $20,000 $20,000
Problem 9 - 3 Solution
Problem 9 - 4
• NPV• Calculate the NPV for the following 20-year projects.
Comment on the acceptability of each• Opportunity cost is 14%a) Initial investment is $10,000; cash inflows are $2,000
per year.b) Initial investment is $10,000; cash inflows are $2,000
per year.c) Initial investment is $10,000; cash inflows are $2,000
per year.
Problem 9 - 4 Solution
Problem 9 - 7
• NPV• Car inventor has offered Simes choice of either one time
payment $1,500,000 today or a series of 5 year-end payments of $385,000
a) If Simes has cost of capital 9%, which form of payment would they choose?
b) What yearly payment would make the two offers identical in value at a cost of capital of 9%
c) Would your answer be different if the yearly payments were made at the beginning of each year? Show the difference.
d) The after-tax cash inflows are projected to $250,000 per year for 15 years. Will this factor change the decision?
Problem 9 - 7 Solution
Problem 9 - 9
• NPV- exclusive projects• Hook industries is
considering the replacement of a drill press
• Cost of capital is 15%a) Calculate NPV of each
press.b) Evaluate acceptability.c) Rank the presses best to
worst
A B CInit. Inv. $85,00
0$60,000
130,000
Year Cash Inflows (CFt)
1 $18,000
$12,000
$50,000
2 $18,000
$14,000
$30,000
3 $18,000
$16,000
$20,000
4 $18,000
$18,000
$20,000
5 $18,000
$20,000
$20,000
6 $18,000
$25,000
$30,000
7 $18,000
$40,000
8 $18,000
$50,000
Problem 9 - 9 Solution
Problem 9 - 9 Solution cont.
Problem 9 - 13
• IRR, investment life and cash inflows• Oak enterprises accepts projects earning more than 15%.
Oak is considering a 10 year project that provides $10,000 annual cash inflows and requires $61,450 initial investment.
a) Determine IRR. Is it acceptable?b) Assuming cash inflows stay same how many additional
years would the flows have to continue to make IRR 15%?c) With given life, initial investment, and cost of capital what is
the minimum annual cash inflow the firm should accept?
Problem 9 - 13 Solution
Problem 9 - 21
• Integrative - Complete investment decision
• Existing– 10yrs ago at $1,000,000– Sells $1,200,000
• New– Cost $2,200,000– 5yrs, MACRS– Sales $1,600,000 increase per
year– Costs 50% of Sales
• Cost of Capital 11%• Tax 40%
MACRS
a) Calculate initial investment.b) Determine incremental operating
cash flows.c) Determine the terminal cash flow.d) Depict on a time line the relevant
cash flows.
Year Percentage1 20%
2 32%
3 19%
4 12%
5 12%
6 5%
Problem 9 - 21 Solution
Problem 9 - 21 Solution cont.