Problem 11 7 capital budgeting criteria a firm with a

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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: Project A ProjectB Year 0 -6000 -18000 Year 1 2000 5600 Year2 2000 5600
Year 3 2000 5600 Year 4 2000 5600 Year 5 2000 5600 a. 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.
Year 2 discounted CF = \$2,000 / (1.14)2= \$1,538.94 Year 3 discounted CF = \$2,000 / (1.14)3= \$1,349.94 Year 4 discounted CF = \$2,000 / (1.14)4= \$1,184.16 Year 5 discounted CF = \$2,000 / (1.14)5= \$1,038.74 Discounted payback period = 4 + (\$172.57/\$1,038.74) = 4.17 years Project B NPV = -\$18,000 + (\$5,600)(3.4331) = \$1,225.36 IRR using a spreadsheet = 16.80% 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? If the projects are independent, both would be accepted since they both have positive NPVs.
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