Module 4 - Case

Capital Budgeting

Assignment:
Part 1. Capital Budgeting Practice Problems

a. Consider the project with the following expected cash flows:

Year
0
1
2
3

Cash flow
-$400,000
$100,000
$120,000
$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?
With a cost of capital of 5%, 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?
[ 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
0
1
2
3

Cash flow
-$815,000
$141,000
$320,000
$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?
[ 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 below. Then write a one-to-two page 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.
Abstract:
Internal rate of return (IRR) is the flip side of net present value (NPV) and is based on
the same principles and the same math. NPV shows the value of a stream of future cash
flows discounted back to the present by some percentage that represents the minimum
desired rate of return, often a company's cost of capital. IRR, on the other hand,
computes a break-even rate of return. It shows the discount rate below which an
investment results in a positive NPV and above which an investment results in a negative
NPV. It is the breakeven discount rate, the rate at which the value of cash outflows equals
the value of cash inflows.

Assignment Expectations:

This assignment consists of a quantitative section (Part 1) and a an essay section (Part 2)
below. Upload both sections as one Word document by the end of the Module.