05%20capital%20budgeting%20criteria%20-%20lecture%20problems%20solutions

05%20capital%20budgeting%20criteria%20-%20lecture%20problems%20solutions

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Lecture problems – capital budgeting criteria I Scream Ice Cream is considering an ad campaign that is expected to cost $500,000 today; produce cash flows of $170,000 in 1 year, $200,000 in 2 years, $250,000 in 3 years, and $100,000 in 4 years; and have a cost of capital of 9 percent. Would the firm accept the project based on NPV? NPV = [C 0 ] + [C 1 / (1+r)] + [C 2 / (1+r) 2 ] + . .. + [C t / (1+r) t ] In this case, NPV= [-500,000] + [170,000 / 1.09] + [200,000 / 1.09 2 ] + [250,000 / 1.09 3 ] + [100,000 / 1.09 4 ] = $88,188 NPV > 0, so the firm would accept the project based on NPV npv(9,-500000,{170000,200000,250000,100000}) 88,188 1
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Lecture problems – capital budgeting criteria I Scream Ice Cream is considering an ad campaign that is expected to cost $500,000 today; produce cash flows of $520,000 in 1 year, $0 in 2 years, $0 in 3 years, and X in 4 years; have a required return of 10 percent; and have an NPV of $20,000. What is X? NPV = [C 0 ] + [C 1 / (1+r)] + [C 2 / (1+r) 2 ] + . .. + [C t / (1+r) t ] In this case, 20,000 = [-500,000] + [520,000 / 1.10] + [0 / 1.10 2 ] + [0 / 1.10 3 ] + [X / 1.10 4 ] = -500,000 + 472,727 + 0 + 0 + [X / 1.10 4 ] So 20,000 + 500,000 – 472,727 = X / 1.10 4 = 47,273 = X / 1.10 4 So X = 47,273 × 1.10 4 = $69,212.40 ≈ $69,212 The expected cash flow in 4 years (X) is $69,212 Confirm: npv(10,-500000,{520000,0,0,69212}) 20,000 2
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Lecture problems – capital budgeting criteria I Scream Ice Cream is considering an ad campaign that is expected to cost $500,000 today; produce cash flows of $170,000 in 1 year, $200,000 in 2 years, $250,000 in 3 years, and $100,000 in 4 years; and have a cost of capital of 9 percent. Would the firm accept the project based on IRR? 0 = [C 0 ] + [C 1 / (1+IRR)] + [C 2 / (1+IRR) 2 ] + . .. + [C t / (1+IRR) t ] In this case, 0 = -500,000 + [170,000/(1+IRR)] + [200,000/(1+IRR) 2 ] + [250,000/(1+IRR) 3 ] + [100,000/(1+IRR) 4 ] irr(-500000,{170000,200000,250000,100000}) 17.09 IRR = 17.09% IRR > the cost of capital of 9%, so the firm would accept the project based on IRR Note that since expected cash flows are conventional, IRR will always lead to the same conclusion as NPV 3
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Lecture problems – capital budgeting criteria I Scream Ice Cream is considering an ad campaign that is expected to cost $500,000 today; produce cash flows of $170,000 in 1 year, $200,000 in 2 years, $250,000 in 3 years, and $100,000 in 4 years; and have a cost of capital of 9 percent. If the ad campaign also involves
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This note was uploaded on 02/03/2011 for the course FINANCE 301 taught by Professor Murray during the Spring '09 term at George Mason.

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05%20capital%20budgeting%20criteria%20-%20lecture%20problems%20solutions

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