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Casestudy Solution A) Project A

This document analyzes and compares three capital budgeting projects (Projects A, B, and C) using various metrics: 1. It calculates the payback period and discounted payback period for each project. Project A has a payback period of 1.6 years and discounted payback period of 1.94 years. Project B has a payback period of 2.25 years and discounted payback period of 2.60 years. 2. It determines the net present value (NPV) of each project using a discount rate of 12%. Project A has an NPV of $1,186, Project B has an NPV of $1,132, and Project C has an NPV of $

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Saurabh Sharma
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70 views3 pages

Casestudy Solution A) Project A

This document analyzes and compares three capital budgeting projects (Projects A, B, and C) using various metrics: 1. It calculates the payback period and discounted payback period for each project. Project A has a payback period of 1.6 years and discounted payback period of 1.94 years. Project B has a payback period of 2.25 years and discounted payback period of 2.60 years. 2. It determines the net present value (NPV) of each project using a discount rate of 12%. Project A has an NPV of $1,186, Project B has an NPV of $1,132, and Project C has an NPV of $

Uploaded by

Saurabh Sharma
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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CASESTUDY SOLUTION

a) Project A.
Year Cash flow Unrecovered investment balance By linear interpolation
----- ---------- -------------------------------- the payback period
0 ( 5000) ( 5000) 1500
1 3500 ( 1500) = 1 + -- --------- = 1.6 years
2 2500 1000 1500 + 1000

Calculation of discounted payback period


Year Cash flow Discounting factor Present Cumulative net cash
at 12 percent Value flow after discounting
------ ----------- ------------------- ------ ---------------------
0 ( 5000) 1.000 ( 5000) ( 5000)
1 3500 0.893 3126 ( 1874)
2 2500 0.797 1993 119
1874
By linear interpolation, the discounted payback period is = 1 + ------------ = 1. 94 years
1874 + 119

Project B
Year Cash flow Unrecovered investment
balance
----- ---------- ----------------------------- By linear interpolation the payback 0
( 5000) ( 5000) 1000
1 1000 ( 4000) period= 2 + ------------- = 2.25years
2 3000 (1000) 1000 + 3000
3 4000 3000
Calculation of discounted payback period
--------------------------------------------
Year Cash flow Discounting factor Present Cumulative net cash
at 12 percent Value flow after discounting
------ ----------- ------------------- ------- ---------------------
0 ( 5000) 1.000 ( 5000) ( 5000)
1 1000 0.893 893 ( 4107)
2 3000 0.797 2391 1716
3 4000 0.712 2848 1132
1716
By linear interpolation, the discounted payback period is = 2 + ----------- = 2.60 years
1716 + 1132
b)

NPV of project A = -5000 + 3500 PVIF (12%, 1yr) + 2500 PVIF (12%, 2yrs) + 1500
PVIF (12%, 3yrs)
= -5000+ 3500 x 0.893 + 2500 x 0. 797 + 1500 x 0.712
= - 5000 + 3126 + 1992 + 1068 = 1186

NPV of project B = -5000 + 1000 PVIF (12%, 1yr) + 3000 PVIF (12%, 2yrs) + 4000
PVIF(12%, 3yrs)
= -5000 + 1000x 0. 893 + 3000 x 0. 797 + 4000 x 0.712
= -5000 + 893 + 2391 + 2848 = 1132
NPV of project C = -5000 + 15000 PVIF( 12%, 1yr) - 10000 PVIF( 12%, 2yrs)
= -5000 + 15000x 0. 893 - 10000 x 0. 797
= -5000 + 13395 - 7970 = 425

c)
Project A

Let the IRR be r . We then have


3500 PVIF( r, 1yr) + 2500 PVIF ( r, 2yrs) + 1500 PVIF ( r, 3yrs) = 5000
Trying r=24 %, LHS = 3500 x 0. 806 + 2500 x 0.650 + 1500 x 0.524
= 2821 + 1625 + 786 = 5232
As the RHS is slightly higher than 5000, we try a higher value for r
Trying r=28 %, LHS = 3500 x 0. 781+ 2500 x 0.610 + 1500 x 0.477
= 2733 + 1525 + 716 = 4974
5232 - 5000
By linear interpolation in the range of 24% and 28%, r = 24 + ( 28-24)x -------------
5232 – 4974
= = 24 + 3.60 = 27.60%

Project B

Let the IRR be r . We then have


1000 PVIF( r, 1yr) + 3000 PVIF ( r, 2yrs) + 4000 PVIF ( r, 3yrs) = 5000
Trying r=20 %, LHS = 1000 x 0. 833 + 3000 x 0.694 + 4000 x 0.579
= 833 + 2082 + 2316 = 5231
As the RHS is slightly higher than 5000, we try a higher value for r
Trying r=24 %, LHS = 1000 x 0. 806+ 3000 x 0.650 + 4000 x 0.524
= 806 + 1950 + 2096 = 4852
5231 - 5000
By linear interpolation in the range of 20% and 24%, r = 20 + ( 24-20)x --------------
5231 – 4852
= = 20 + 2.44 = 22.44%
Project C

As the cash flow stream is non-conventional, IRR is not uniquely defined.


d)
Project A

Present value of the costs = 5000


Present value of the benefits discounted at the cost of capital 12 percent
= 3500 PVIF( 12%, 1yr) + 2500 PVIF (12%, 2yrs) + 1500 PVIF( 12%, 3yrs)
= 3500 x 0.893 + 2500 x 0.797 + 1500 x 0.712 = 3126 + 1992 + 1068 = 6186
6186
We have -------------- = 5000
( 1 + MIRR)3

( 1 + MIRR)3 = 1. 2372 or 1+ MIRR =1.0735. Therefore MIRR= 7.35 percent

Project B

Present value of the costs = 5000


Present value of the benefits discounted at the cost of capital 12 percent
= 1000 PVIF( 12%, 1yr) + 3000 PVIF (12%, 2yrs) + 4000 PVIF( 12%, 3yrs)
= 1000 x 0.893 + 3000 x 0.797 + 4000 x 0.712 = 893 + 2391 + 2848 = 6132
6132
We have -------------- = 5000
( 1 + MIRR)3

( 1 + MIRR)3 = 1. 2264 or 1+ MIRR =1.0704. Therefore MIRR= 7.04 percent

Project C

Present value of the costs = 5000 + 10,000 PVIF ( 12%, 2yrs)


= 5000 x 10,000 x 0.797 = 5000 + 7970 = 12,790
Present value of the benefit discounted at the cost of capital 12 percent
= 15,000 PVIF( 12%, 1yr) = 15,000 x 0.893 = 13,395
13,395
We have -------------- = 12,790
( 1 + MIRR)2

( 1 + MIRR)2 = 1.0328 or 1+ MIRR =1.0163. Therefore MIRR= 1.63 percent

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