Capital Budgeting - Research Paper Example

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Capital Budgeting

c. Mutual exclusivity requires a business organization to choose only one project. Consistent with the goal of every company to maximize its wealth, the project with the higher NPV is chosen regardless of the investment cost. Thus, project B is chosen over project A even though its IRR and MIRR is lower.
Since the lowest even life cycle of the projects under consideration is 12, the Equivalent Annual Annuity is utilized in order to make the best decision. Thus, the present values of cash flows within the first three years of each project are computed. Afterwards, these are divided by the PVIFA of the projects. For project A, this means dividing it with the PVIFA within 3 years at 8% while for project B a life of 4 years and 8% discount rate is utilized. At the end, the four year alternative is chosen because it has a higher NPV of ($63,100.92).
a. Any investment should still be evaluated regardless of the fact that the investment is higher than the cash inflow. It should be noted that the profitability of an investment is not solely based on whether the investment exceeds the cash inflow because of the time value of money. Evaluation of the project using different required rates of return also reveals that NPVs can be positive or negative depending on the discount rate.
b. ...Show more

Summary

c. The project should be accepted because it satisfies all the criteria as shown by the results of the computation. Based on above, the NPV is positive which also implies a positive profitability index. Also, since the project is expected to generate higher values that cost of capital both IRR and MIRR are higher than the required rate of return of 14%.
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