Part 1 - CAPITAL BUDGETING a. Consider the project with the following expected cash flows:

Part 1. Capital Budgeting Practice Problems

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"].

b. Consider a project with the expected cash flows:

Year Cash flow

0 - $615,000

1 + 141,000

2 + 300,000

3 + $300,000

• What is this project's internal rate of return?

• If the discount rate is 0%, what is this project's net present value?

• If the discount rate is 4%, what is this project's net present value?

• If the discount rate is 8%, what is this project's net present value?

• If the discount rate is 12%, what is this project's net present value?

Draw 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?

[Observe the graph and write a short paragraph stating what the graph 'shows

c. A project requiring a $3.2 million investment has a profitability index of 0.97
What is its net present value? (Remember: Profitability Index is defined as Present Value of the proceeds divided by the initial investment)

 

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