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

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

This preview shows pages 1–5. Sign up to view the full content.

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

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
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
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

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
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
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 9

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

This preview shows document pages 1 - 5. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online