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CHAPTER 10 The Basics of Capital Budgeting

CHAPTER 10 The Basics of Capital Budgeting. Problem solving. Lidija Dedi. Problem 1: Projects X i Y have following cash flows. Calculate for projects X and Y:. Payback period Discounted payback period Net present value Internal rate of return The firm’s cost of capital is 10 %.

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CHAPTER 10 The Basics of Capital Budgeting

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  1. CHAPTER 10The Basics of Capital Budgeting Problem solving Lidija Dedi

  2. Problem 1:Projects X i Y have following cash flows

  3. Calculate for projects X and Y: • Payback period • Discounted payback period • Net present value • Internal rate of return • The firm’s cost of capital is 10 %

  4. a) Payback period for project X

  5. a) Payback period for project X

  6. Payback period for project Y

  7. b) Discounted payback period

  8. Discounted payback period for X

  9. Discounted payback period for X

  10. Discounted payback period for X

  11. Discounted payback period for X

  12. Discounted payback period for project Y

  13. Discounted payback period for project Y

  14. Discounted payback period for project Y

  15. Discounted payback period for project Y

  16. c) Net Present Value for project X

  17. Net Present Value for project Y • Project Y – equal Cash Flows

  18. c) Iternal Rate of Return X

  19. c) Iternal Rate of Return X

  20. Interpolation

  21. Internal Rate of Return for project Y Equal Cash Flows INTERPOLATION

  22. Problem 2: • ABC company is considering a project with the following expected cash flows:

  23. - The project’s WACC is 10 percent- What is the project’s payback period and discounted payback

  24. Problem 3: • You are considering the purchase of an investment that would pay you $5.000 per year for Years 1-5, $3.000 per year for Years 6-8, and $2.000 per year for Years 9 and 10 • If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?

  25. Problem 4: • ABC Inc. requires a new machine. Two companies have submitted bids, and you have been assigned the task of choosing one of the machines. Cash flow analysis indicates the following:

  26. What is the internal rate of return for each machine?

  27. Problem 5: • The firm’s project has a cost of $275.000 and is expected to provide after-tax annual cash flows of $73.306 for eight years. • The firm’s management is uncomfortable with the IRR reinvestment assumption and prefers the modified IRR approach. • You have calculated a cost of capital for the firm of 12 percent. • What is the project’s MIRR?

  28. Problem 6: • A company is analyzing two mutually exclusive projects, S and L, whose cash flows are shown below: 0 1 2 3 Years - 1.100 1.000 350 50 S - 1.100 0 L 300 1.500

  29. The company cost of capital is 12 percent • What is the regular IRR of the better project, that is, the project which the company should choose if it wants to maximize its stock price?

  30. Problem 7: • ABC corporation is considering a project with the following cash flows:

  31. The project has a simple payback period of exactly two years. • The project’s cost of capital is 12% • What is the project’s modified internal rate of return (MIRR)?

  32. Problem 8: • Alpha Hotels is considering two mutually exclusive projects, Project A and project B. • The cash flows from the projects are summarized below:

  33. The two projects have the same risk. • At what cost of capital would the two projects have the same net present value?

  34. Problem 9: • ABC corporation estimates that its cost of capital is 11 percent • The company is considering two mutually exclusive projects whose after-tax cash flows are as follows:

  35. What is the modified internal rate of return of the project with highest NPV?

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