FIN5FMA Tutorial 3 solutions - FINANCIAL MANAGEMENT(FIN5FMA...

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FINANCIAL MANAGEMENT (FIN5FMA), SEMESTER 1, 20 15 – SOLUTIONS TO ASSIGNED QUESTIONS FOR TUTORIAL 3 Chapter 11 Problem 11-7 (Capital budgeting criteria) A firm with a 14% WACC is evaluating two projects for this year’s capital budget. After-tax cash flows, including depreciation, are as follows: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Project A -$6,000 $2,000 $2,000 $2,000 $2,000 $2,000 Project B -$18,000 $5,600 $5,600 $5,600 $5,600 $5,600 a) Calculate NPV, IRR, MIRR, payback, and discounted payback for each project.
Modified IRR (MIRR) calculations: Future value of cash flows re-invested at the WACC of 14%: Year 1 CF = $5,600(1.14) 4 = $9,458.18 Year 2 CF = $5,600(1.14) 3 = $8,296.65 Year 3 CF = $5,600(1.14) 2 = $7,277.76 Year 4 CF = $5,600(1.14) 1 = $6,384.00 Year 5 CF = $5,600 Terminal value = $37,016.59 PV of Project cost = $18,000 $18,000 = $37,016.59 / (1 + MIRR) 5 MIRR = 0.1551 (15.51%) Payback period = $18,000 / $5,600 = 3.21 years Discounted payback period calculations: Year 1 discounted CF = $5,600 / 1.14 = $4,912.28 Year 2 discounted CF = $5,600 / (1.14) 2 = $4,309.02 Year 3 discounted CF = $5,600 / (1.14) 3 = $3,779.84 Year 4 discounted CF = $5,600 / (1.14) 4 = $3,315.65 Year 5 discounted CF = $5,600 / (1.14) 5 = $2,908.46 Discounted payback period = 4 + ($1,683.21/$2,908.46) = 4.58 years b) Assuming the projects are independent, which one(s) would you recommend?
c) If the projects are mutually exclusive, which would you recommend?

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