IF Study Questions for Capital Budgeting

IF Study Questions for Capital Budgeting - BUSFIN 1030...

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BUSFIN 1030 –Introduction to Finance Study Questions for Capital Budgeting 1. Use the information below to answer parts a through f . Consider a 4-year project. The project requires an initial investment of $1 million in equipment that is to be depreciated straight-line to zero over the life of the project with no salvage value at the end. The appropriate discount rate is 25%. The annual net income and cash flow from the project are expected to be as follows: Yea r Net income Cash flow 1 $150,000 $400,000 2 $220,000 $450,000 3 $130,000 $500,000 4 –$240,000 $100,000 a. State the decision rule based on average accounting return (AAR). b. State the decision rule based on payback rule. c. State the decision rule based on discounted payback rule. d. State the decision rule based on net present value (NPV). e. State the decision rule based on internal rate of return (IRR). f. State the decision rule based on profitability index (PI). 2. Use the cash flows from the following two mutually exclusive projects to answer parts a and b . Yea r Project A Project B 0 –$500 –$1,000 1 $300 $700 2 $400 $500 3 $200 $300 a. State the decision rule based on internal rate of return (IRR) analysis. b. State the decision rule based on profitability index (PI) analysis if the required rate of return is 10%. Compare your decision to that based on net present value (NPV) analysis. 3. Consider the cash flows of the following two mutually exclusive projects: t Project A Project B 0 $1,000.00 $2,500.00 1 $604.15 $- 2 $604.15 $- 3 $604.15 $- 4 $604.15 $5,000.00 a. Calculate the net present value of these projects if the discount rate is 5%. Which project should be preferred? b. Calculate the net present value of these projects if the discount rate is 15%. Which project should be preferred? c. Calculate the internal rate of return for each project and their crossover rate. Then state the correct decision rule based on internal rate of return. © 2003-2009 Mehmet Yalin 1
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BUSFIN 1030 –Introduction to Finance Study Questions for Capital Budgeting © 2003-2009 Mehmet Yalin 2
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BUSFIN 1030 –Introduction to Finance Study Questions for Capital Budgeting 4. Moody Pharmaceuticals Corp. is planning to launch an anti-depression drug, Just Lose It . The company has spent $500 million for research and development of this medication and paid a marketing research
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IF Study Questions for Capital Budgeting - BUSFIN 1030...

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