Running head: EVALUATING CAPITAL EXPENDITURES 1
Evaluating Capital Expenditures
NPV = F O + + +,,,
Project A
NPV = - 30 + + + +
= - 30 +4.46 + 7.972 +10.677 + 12.71
= 5.82
IRR = F O + + +,,, = 0
- 30 + + + + =0
Using excel we can compute the IRR that leads to 0 cash at the end of the period
IRR = 19.19%
MIRR
| Cash flows | FV Factor | Terminal Value | |
|
0 |
-30 |
||
|
1 |
5 |
1.404928 |
7.02464 |
|
2 |
10 |
1.2544 |
12.544 |
|
3 |
15 |
1.12 |
16.8 |
|
4 |
20 |
1 |
20 |
|
56.36864 |
|||
MIRR = -1 = = 17.08%
Payback period = 5+10+15 = 30 = three years
Discounted Payback period
| Discount rate | Discounted CF | Cumulative CF | ||
|
0 |
-30 |
|||
|
1 |
5 |
1.12 |
4.464286 |
4.464286 |
|
2 |
10 |
1.2544 |
7.971939 |
12.43622 |
|
3 |
15 |
1.404928 |
10.6767 |
23.11293 |
|
4 |
20 |
1.573519 |
12.71036 |
35.82329 |
|
35.82329 |
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Discounted Payback period = year before full recovery +unrecovered funds at start/cash flow during the year
=3 + 6.88707/12.71036 = 3 +0.54 = 3.54 years
Project B
NPV =- 30 + + + +
= - 30 + 17.86 + 7.972 + 5.69 +3.4
= 4.93
IRR = F O + + +,,, = 0
- 30 + + + + =0
Using excel we can compute the IRR that leads to 0 cash at the end of the period
IRR = 22.5%
| Cash flows | FV Factor | Terminal Value | ||
|
0 |
-30 |
|||
|
1 |
20 |
1.404928 |
28.09856 |
|
|
2 |
10 |
1.2544 |
12.544 |
|
|
3 |
8 |
1.12 |
8.96 |
|
|
4 |
6 |
1 |
6 |
|
|
55.60256 |
||||
MIRR = -1 = = 16.68%
Payback period = 20+10 =30 = two years
Discounted payback period
| Discount rate | Discounted CF | Cumulative CF | ||
|
0 |
-30 |
|||
|
1 |
20 |
1.12 |
17.85714 |
17.85714 |
|
2 |
10 |
1.2544 |
7.971939 |
25.82908 |
|
3 |
8 |
1.404928 |
5.694242 |
31.52332 |
|
4 |
6 |
1.573519 |
3.813108 |
35.33643 |
|
35.33643 |
Discounted Payback period = year before full recovery +unrecovered funds at start/cash flow during the year
=2 +4.17092/5.694242 = 2+0.73 =2.73 years
Conflicts arise between NPV IRR for independent projects arise if the two give conflicting results. The difference in the cash flow patterns gives the differences in which case a project that has a higher NPV reports lower IRR and therefore likely to be rejected if IRR is used (Sherman, 2011).
Problem 2: New Project
Initial investment outlay for the machine includes the base price of $100,000. The installation costs $10,000 and the feasibility test. The rest of the amounts are not included in the determination of the initial investment. The $7000 spent last year does not affect the computation of the initial investment of the new machine (Sherman, 2011).
References
Brigham, E. F., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.). Boston, MA: Cengage.
Sherman, E. H. (2011). Finance and accounting for nonfinancial managers (3rd ed.). New York, NY: Amacom
