Lesson on Capital Budgeting

Question 1

Thepresident of Georgetown Company is evaluating three investment projects. Thenet cash flows for each project are estimated as follows:

Investment Projects
	A	B	C
Initial Cost	($212 508)	($227 448)	($217 180)
Year 1	$ 90 000	$ 60 000	$ 50 000
2	90 000	60 000	50 000
3	90 000	60 000	50 000
4		60 000	50 000
5		60 000	50 000
6			50 000
7			50 000
8			50 000

 

Compute Each of the following:

i)                   The payback period for each investmentproject

ii)                 The net present value for Eachinvestment project

iii)               The profitability index for Eachinvestment project.

iv)               Rank the three investment projects basedon the three measures in (i-iii)   (CAPE2010)

Assignment must be completed in groups. Attach anaction plan outlining the task completed by each member.

 Solutions

Payback Period

Project A                     Project B                     ProjectC

212508                     227448                                  217180

90000                         60000                                  50000

 

2.3612 yrs                   3.7908yrs                   4.3436 yrs

 

.36123 x 12                 .7908x 12                   .3436 x 12

 

2 years 4 months         3years 8 months         4 years 4 months

Net Present Value

Assuming that annuity for the Net Present Value is10%

 ProjectA

Years	Cash Flow	Discount Factor	Present Value
0	(212,508)		(212,508)
1 to 3	90,000	2.4869	223,821
		Net Present Value	11,313

Project B

Years	Cash Flow	Discount Factor	Present Value
0	(227,448)		(227,448)
1 to 5	60,000	3.7908	227,448
		Net Present Value	0

Project C

Years	Cash Flow	Discount Factor	Present Value
0	(217,180)		(217,180)
1 to 8	50,000	5.3349	266,745
		Net Present Value	49,565

Profitability Index 

                                                                             Projects

 

Profitability                             528,576                       862,208                       1158,640

                                                272,508                       227,448                       217180

 

                                                =2.49                           =3.79                           =5.3

 

Profitability Index                         Present Value ofFuture Cash Flow

                                                            InitialInvestment Required

Project A                                 270,000/212,508= 1.27

 Project B                                 300,000/227,448= 1.318

 Project C                                 400,000/217,180=  1.841