Capital budgeting criteria a firm with a 14 wacc is

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PROBLEM 11-7CAPITAL 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:Project A ProjectBYear 0 -6000 -18000Year 1 2000 5600Year2 2000 5600
Year 32000 5600Year 4 2000 5600Year 5 2000 5600a. Calculate NPV, IRR, MIRR, payback, and discounted payback for each project.b. Assuming the projects are independent, which one(s) would you recommend?c. If the projects are mutually exclusive, which would you recommend?d. Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?a/ Calculate NPV, IRR, MIRR, payback, and discounted payback for each project.Project ANPV = -$6,000 + ($2,000)(3.4331) = $866.20IRR using a spreadsheet = 19.86%Modified IRR (MIRR) calculations:Future value of cash flows re-invested at the WACC of 14%:Year 1 CF = $2,000(1.14)4= $3,377.92Year 2 CF = $2,000(1.14)3= $2,963.09Year 3 CF = $2,000(1.14)2= $2,599.20Year 4 CF = $2,000(1.14)1= $2,280.00Year 5 CF = $2,000Terminal value = $13,220.21PV of Project cost = $6,000$6,000 = $13,220.21 / (1 + MIRR)5MIRR = 0.1712 (17.12%)Payback period = $6,000 / $2,000 = 3.00 yearsDiscounted payback period calculations:Year 1 discounted CF = $2,000 / 1.14 = $1,754.39
Year 2 discounted CF = $2,000 / (1.14)2= $1,538.94Year 3 discounted CF = $2,000 / (1.14)3= $1,349.94Year 4 discounted CF = $2,000 / (1.14)4= $1,184.16Year 5 discounted CF = $2,000 / (1.14)5= $1,038.74Discounted payback period = 4 + ($172.57/$1,038.74) = 4.17 yearsProject BNPV = -$18,000 + ($5,600)(3.4331) = $1,225.36IRR using a spreadsheet = 16.80%Modified IRR (MIRR) calculationsFuture value of cash flows re-invested at the WACC of 14%:Year 1 CF = $5,600(1.14)4= $9,458.18Year 2 CF = $5,600(1.14)3= $8,296.65Year 3 CF = $5,600(1.14)2= $7,277.76Year 4 CF = $5,600(1.14)1= $6,384.00Year 5 CF = $5,600Terminal value = $37,016.59PV of Project cost = $18,000$18,000 = $37,016.59 / (1 + MIRR)5MIRR = 0.1551 (15.51%)Payback period = $18,000 / $5,600 = 3.21 yearsDiscounted payback period calculations:Year 1 discounted CF = $5,600 / 1.14 = $4,912.28Year 2 discounted CF = $5,600 / (1.14)2= $4,309.02Year 3 discounted CF = $5,600 / (1.14)3= $3,779.84Year 4 discounted CF = $5,600 / (1.14)4= $3,315.65Year 5 discounted CF = $5,600 / (1.14)5= $2,908.46
Discounted payback period = 4 + ($1,683.21/$2,908.46) = 4.58 yearsb/ Assuming the projects are independent, which one(s) would you recommend?If the projects are independent, both would be accepted since they both have positive NPVs.

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