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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. b. For this project, there are two computed IRRs which is due to the fact that there is a change in the sign of cash flow for the project's life span. For the first year, there is an outflow (negative cash flow) while in the second year cash flow is positive. During the end of its life, the project again has a negative cash flow. Since, the sign changes twice, two IRRs are expected. As computed by Excel, these IRRs are 10.09% and 20.81% indicating that NPVs are zero in these discount rates.
On the other hand, MIRR is approximately equal to the discount rate where it is computed. This is due to assumption of MIRR that cash flows are reinvested at the discount rate.
c. Figure 1 in the Appendix shows the computed NPVs at discount rates of 5% (NPV=-$730.16) , 15% (NPV=$215.50), 18% (NPV=$159.44) and 25% (NPV=-$400.00). Thus, the project should be accepted at 15% and 18% discount rates. Noting the IRRs above, projects should be accepted at discount rates within 10.09% and 20.81%.
Number 5.
a. For the proposed replacement, NPV is computed to be $43,103.55 while IRR and MIRR are 19.60% and 16.98%, respectively.
b. The positive NPV as well as the IRR and MIRR which are higher than the discount rate indicate that Maltpon Company should replace its old machine.

Number 6.
a. The introduction of the new product will yield a positive NPV of $286,590. Consistent with this, IRR is computed to be 20.94% which is higher than the discount rate of 15%. MIRR is 19.30%. Thus, the project should be accepted.



























APPENDICES

Appendix 1.
a) Net Present Value: NPV = PV(Cash flows) - Initial Investment (C0)

PV =
PV= -10000/(1+14%)1 + 20000/(1+14%)2 + 20000/(1+14%)3 + 20000/(1+14%)4 + 20000/(1+14%)5
PV= -8771.93+15389.35 + 13499.43 + 11841.61+ 10387.37
= ...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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