Prof. Dr.

Rainer Stachuletz
Corporate Fincance and
Investment Policy
ballou@zedat.fu-berlin.de

Case 8
Chapter 8 Capital Budgeting

Capital Budgeting Process And Techniques

Contact Manufacturing, Inc., is considering two alternative investment proposals. The
first proposal calls for a major renovation of the companys manufacturing facility. The
second involves replacing just a few obsolete pieces of equipment in the facility. The
company will choose one project or the other this year, but it will not do both. The cash
flows associated with each project appear below and the firm discounts project cash
flows at 15 percent.
Year
0
1
2

Renovate
$9,000,000
3,000,000
3,000,000

Replace
$2,400,000
2,000,000
800,000

3,000,000

200,000

4
5

3,000,000
3,000,000

200,000
200,000

Assignment:
1. Calculate the payback period of each project and based on this criteria for which project
would you recommend acceptance?
2. Calculate the net present value (NPV) of each project and based on this criteria for
which project would you recommend acceptance?
3. Calculate the internal rate of return (IRR) of each project and based on this criteria
for which project would you recommend acceptance?
4. Calculate the profitability index (PI) of each project and based on this criteria for
which project would you recommend acceptance?
5. Overall, you should find conflicting recommendations based on the various criteria.
Why is this occurring?
6. Chart the NPV profiles of these projects. Label the intersection points on the X and Y
axis and the crossover point.
7. Based on this NPV profile analysis and assuming the WACC is 15%, which project is
recommended? Why?
8. Based on this NPV profile analysis and assuming the WACC is 25%, which project is
recommended? Why?
9. Discuss the important elements to consider when deciding between these two
projects.