CAPITAL BUDGETING
a. Consider the project with the following expected cash flows:
Year Cash flow
0 - $500,000
0 - $500,000
1 $100,000
2 $110,000
3 $550,000
• If the discount rate is 0%, what is the project's net present value?
• If the discount rate is 4%, what is the project's net present value?
• If the discount rate is 8%, what is the project's net present value?
• If the discount rate is 10%, what is the project's net present value?
• What is this project's internal rate of return?
Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the "x" axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. connect the four points using a free hand 'smooth' curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis?
[Look at the graph you draw and write a short paragraph stating what the graph 'shows"].
SOLUTION
PREVIEW [Excel sheet with graph]
|
year
|
Cash flow
|
|||||
|
0
|
-500,000
|
($500,000.00)
|
($500,000.00)
|
($500,000.00)
|
($500,000.00)
|
($500,000)
|
|
1
|
100,000
|
$100,000.00
|
$96,153.85
|
$92,592.59
|
$90,909.09
|
$83,333
|
|
2
|
110,000
|
$110,000.00
|
$101,701.18
|
$94,307.27
|
$90,909.09
|
$76,389
|
