41 Capital Budgeting Exercises: Three independent projects are under considerati

Question

41 Capital Budgeting Exercises: Three independent projects are under consideration for capital budgeting purposes. Their respective initial investment, cost of capital, and cash flows are provided below. Use the following capital budgeting techniques to evaluate all three projects and indicate which project should be undertaken, assuming there is no budget constraint: A. Payback period method B. Discounted payback period method C. Net present value method D. E. IRR method Profitability index method Initial Investment Cost of Capital Target payback period Project I $125,000 9% Project 3 $148,000 10% $140,000 7% 4 years 4 years 4 years Cash flows $40,000 40,000 30,000 30,000 30,000 Year 1 Year 2 $30,000 30,000 35,000 35,000 35,000 $36,000 36,000 36,000 46,000 46,000 Year 3 Year 4 Year 5 Capital Budgeting Spreadsheet Example 2 Project 3 Which project(s) should be accepted? Project 1 . Payback period Discounted payback period NPV IRR Pl

Explanation / Answer

Answer:

Formulas used in the calculation:

Payback period is the time when you recover your investment in the project with out taking time value of money in to consideration

Dicounted pay back is when you take time value of money in to consideration. calculate present values

Present value = cash flow / ( 1 + interest rate/100) ^ ( no of years)

IRR is the value at which NPV equals to 0

Profitability index = Sum of present value of cash flows/Initial investment

Calculation for project 1

Project 2

Project 3

Final table for project selection

Project 1 9 Year 0 1 2 3 4 5 Intial investment -125000 Cash flows 30000 30000 35000 35000 35000 Net cash flows -125000 30000 30000 35000 35000 35000 Payback period 3.857143 Present value -125000 27522.94 25250.4 27026.42 24794.88 22747.6 Discounted pay back period 4.897034 NPV 2342.238 IRR 1% Profitability Index 1.018738

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