MODULE 4 - CASE

Module 4 - Case



FIN301 - Principles of Finance

Module 4 - Case

Capital Budgeting

Part 1:

a)

year

Cash flow

PV @ 0%

PV @ 2%

PV @ 6%

PV @ 11%

0

($400,000)

($400,000.00)

($400,000.00)

($400,000.00)

($400,000.00)

1

$100,000

$100,000.00

$98,039.22

$94,339.62

$90,090.09

2

$120,000

$120,000.00

$115,340.25

$106,799.57

$97,394.69

3

$850,000

$850,000.00

$800,973.98

$713,676.39

$621,512.67

NPV =

$670,000.00

$614,353.45

$514,815.59

$408,997.46

IRR =

46%

43%

37%

31%

Discount Rate

NPV

0%

$670,000.00

2%

$614,353.45

6%

$514,815.59

11%

$408,997.46

b)

year

Cash flow

PV @ 1%

PV @ 4%

PV @ 10%

PV @ 18%

0

($815,000)

($815,000.00)

($815,000.00)

($815,000.00)

($815,000.00)

1

$141,000

$139,603.96

$135,576.92

$128,181.82

$119,491.53

2

$320,000

$313,694.74

$295,857.99

$264,462.81

$229,819.02

3

$440,000

$427,059.67

$391,158.40

$330,578.51

$267,797.58

NPV =

$65,358.36

$7,593.31

($91,776.86)

($197,891.87)

IRR =

3%

0%

-5%

-12%

Discount Rate

NPV

1%

$65,358.36

4%

$7,593.31

10%

($91,776.86)

18%

($197,891.87)

c)

Profitability Index = Present value of Cash inflows =

$4.20 Initial investments

Present value of Cash inflows =

4.2

x

0.94

=

3.948

NPV = Present value of cash inflows - initial investment

=

3.948

-

$4.20

=

($0.25)

Part 2:

NPV

If a NPV of an investment is greater than 0, then the investment would add value to the firm, therefore we will accept this investment. If the NPV of an investment is less than 0, this means the investment will take away value from the firm; therefore it is best to reject this project. Also if the NPV = 0, then the investment will give neither gain nor loss to the value of the firm.

Strengths

NPV is also known as net present value. It is a term that is used in accounting for capital budget, which subtracts the current value of net cash flow present value of cash flows. Then this value is compared with the ratios of projected profitability for the project in the future. NPV is useful, especially to investors because it compares the value of money today compared to the value of that money in the future after taking inflation and return into account. The project is rejected if the calculated NPV is less than zero is negative, because cash flows are negative.

Weaknesses

As per the proportional principle, the future value of money is usually ...