Capital Budgeting Project
Channing Oil Services (COS) is a company that supplies drilling equipment used on off-shore oil platforms. COS uses three different guidelines for determining the viability of capital projects.
- Payback is the time it takes to make back the initial investment.
- Internal Rate of Return is the discount rate that sets the Present Value of future Cash Flows equal to the initial investment.
- Net Present Value is the sum of the Present Values of incoming and outgoing cash flows over a period of time, given a required rate of return.
COS expects capital projects to have a Payback less than or equal to 3 years. Its target Internal Rate of Return is greater than 16%. Its required return for cash flows is greater than 16%.
The company has two projects available for consideration with the following Net Cash Flow projections:
|
Year
|
Project A
|
Project B
|
|
0
|
-$30,000
|
-$45,000
|
|
1
|
$15,000
|
$5,000
|
|
2
|
$10,000
|
$5,000
|
|
3
|
$10,000
|
$20,000
|
|
4
|
$5,000
|
$55,000
|
Your task is to analyze the cash flows and make a recommendation on which project(s) to undertake. COS could take on either Project A, Project B, or both.
1. What is the payback period for each project? Which of the projects would the firm accept based on payback period? You can recommend either one, both or neither one.
2. What is the internal rate of return for each project? Which of the projects would the firm accept based on IRR?
3. What is the NPV for each project? Which of the projects would the firm accept based on NPV?
4. Which of the projects would you recommend that the firm accept? Why (or under what conditions)?
Submit a well-documented, professionally explained Excel workbook as well as a professionally written and formatted Word document summarizing your answers to the questions above (where appropriate, you may refer to specifics in your Excel workbook).