Please show all work associated with solvoing this problem. Thanks! This assignm

Question

Please show all work associated with solvoing this problem. Thanks!

This assignment entails computing net present value (NPV) and internal rate of return (IRR) and solving capital budgeting problems.

Management of a firm with a cost of capital of 12 percent is considering a $100,000 investment with annual cash flow of $44,524 for three years.

a. What are the investment's net present value and internal rate of return?

b. The internal rate of return assumes that each cash flow is reninvested at the internal rate of return. It that investment rate is achieved, what is the total value of the cash flows at the end of the third year?

c. The net present value technique asumes that each cash flow is reinvested at the firm's cost of capital. What would be the total value of the cash flows at the end of the third year, if the funds are reinvested at the firms's cost of capital?

Explanation / Answer

Here we have Cost of Capital Ks=12%, Initial Inv = $100,000 & Annual CF=$44524 for 3 yrs a. NPV = Initial Inv + PV of CFs PV of annuity of $1 for 3 Yrs at 12% = PVIFA(12%,3) = 2.40183 SO PV of Cfs = 2.40183*$44524 = $106,939 So NPV = -100,000+106,939 = $6939.....................Ans (a1) IRR = IRR(CFs) = IRR(-100000,44524,44524,44524) = 16% .........Ans (a2) b. IRR = 16%. SO Annual Cfs are reinvested at 16%. Maturity is 3 yrs. SO this is like a Future Value of annuity of CFs for 3 yrs with Disc rate = 16%. So FV of annuity of $1 is given by FVIFA(16%,3) = 3.5056 So Total Value of CF at end of 3rd Year = 3.5056*44524 = $156,083 ......Ans (b) c. If Cfs are invested at Firms cost of capital = 12%. SO this is like a Future Value of annuity of CFs for 3 yrs with Disc rate = 12%. So FV of annuity of $1 is given by FVIFA(12%,3) = 3.3744 So Total Value of CF at end of 3rd Year = 3.3744*44524 = $150,242 ......Ans (c)

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