Part 1. Capital Budgeting Practice Problems
a. Consider the project with the following expected cash flows:
Year Cash flow
0 - $400,000
1 $100,000
2 $120,000
3 $850,000
If the discount rate is 0%, what is the project's net present value?
If the discount rate is 2%, what is the project's net present value?
If the discount rate is 6%, what is the project's net present value?
If the discount rate is 11%, what is the project's net present value?
What is this project's modified internal rate of return?
Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the "x" axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. connect the four points using a free hand 'smooth' curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis?
[You can't upload the graph unto Coursenet. Look at the graph you draw and write a short paragraph stating what the graph 'shows"]..
b. Consider a project with the expected cash flows:
Year Cash flow
0 -$815,000
1 $141,000
2 $320,000
3 $440,000
What is this project's internal rate of return?
If the discount rate is 1%, what is this project's net present value?
If the discount rate is 4%, what is this project's net present value?
If the discount rate is 10%, what is this project's net present value?
If the discount rate is 18%, what is this project's net present value?
Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the "x" axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. connect the four points using a free hand 'smooth' curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis?
[You can't upload the graph unto Coursenet. Observe the graph and write a short paragraph stating what the graph 'shows
c. A project requiring a $4.2 million investment has a profitability index of 0.94. What is its net present value? (Remember: Profitability Index is defined as Present Value of the proceeds divided by the initial investment)
Part 2.
Read the article linked below. Then write a paper answering the following question:
Which method do you think is the better one for making capital budgeting decisions - IRR or NPV?
Defend your answer with references to the background materials.
Please read the following article which is available in Proquest:
Internal rate of return
Computerworld; Framingham; Feb 17, 2003; Gary H Anthes