3.6 Capital Budgeting, part 2 - Solutions

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3.6 Capital Budgeting, part 2 - Solutions


Pages:
10
School:
University of Texas at Austin
Course:
Fin 320f - Foundations of Finance
Foundations of Finance Documents

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FIN320F Foundations of Finance 3.6 Capital Budgeting, part 2 - Solutions 1) Amateur Access, Inc. sometimes uses the payback method to select capital projects. The maximum acceptable payback period is two years. Amateur is now faced with two, mutually exclusive investment opportunities, Project X and Project Y, as shown below: Project X Project Y Initial Investment: $10,000 $10,000 Operating Cash Inflows: Year 1 $5,000 $3,000 Year 2 5,000 4,000 Year 3 1,000 3,000 Year 4 100 4,000 Year 5 100 3,000 a) What is the payback period for each project? Project X Project Y Initial Investment: $(10,000) $(10,000) Add Inflows: Year 1 $5,000 $3,000 Year 2 5,000 4,000 Year 3 0 3,000 0 Payback Period 2 years 3 years b) According to the payback method, which project(s) should Amateur accept? Using the payback method, Amateur should select only project X. 2) Compute the NPV of each project using a discount rate of 9%. If Amateur Access used the NPV approach to selecting capital projects, which project(s) would the company implement? PROJECT X Step 1: Initial investment = $10,000 cash outflow Step 2: Operating cash flows = See table above. Step 3: Discount rate = 9% Step 4: Determine the PV of future cash flows. Calculate the PV of each of the five cash flows. Thereafter, sum the five PVs to find the total PV. FV1 = $5,000 r = 9% m = 1 n1 = 1 year N = 1 × 1 I% = 9 ÷ 1 PM T = 0 FV = 5000 PV = AL PH A EN TE R = -4587.16 FV2 = $5,000 r = 9% m = 1 n2 = 2 years N = 2 × 1 I% = 9 ÷ 1 PM T = 0 FV = 5000 SourceDocument.docx Page 1 of 10 FIN320F Foundations of Finance 3.6 Capital Budgeting, part 2 - Solutions PV = AL PH A EN TE R = -4208.40 FV3 = $1,000 r = 9% m = 1 n3 = 3 years N = 3 × 1 I% = 9 ÷ 1 PM T = 0 FV = 1000 PV = AL PH A EN TE R = -772.18 FV4 = $100 r = 9% m = 1 n4 = 4 years N = 4 × 1 I% = 9 ÷ 1 PM T = 0 FV = 100 PV = AL PH A EN TE R = -70.84 FV5 = $100 r = 9% m = 1 n5 = 5 years N = 5 × 1 I% = 9 ÷ 1 PM T = 0 FV = 100 PV = AL PH A EN TE R = -64.99 PV1 $4,587.16 PV2 4,208.40 PV3 772.18 PV4 70.84 PV5 64.99 Total PV: $9 ,703.57 SourceDocument.docx Page 2 of 10 FIN320F Foundations of Finance 3.5 Capital Budgeting, part 2 - Solutions Step 5: Determine NPV and analyze NPV = PV of future cash flows – Initial Investment NPV = $9,703.57 – $10,000 = $(296.43) Alternate method: (On a TI graphing calculator, ...


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