School

Concordia University **We aren't endorsed by this school

Course

FINANCE FINA 395

Subject

Finance

Date

Nov 20, 2023

Type

Other

Pages

6

Uploaded by AgentElectron2059 on coursehero.com

Chapter 7: Net Prevent Value and Other Investment Rules
1) What is Capital Budgeting
2) Examples of Capital Budgeting Projects
3) Why is Capital Budgeting so Important
4)
Classification of Capital Budgeting Projects
5) Classification of Capital Budgeting Projects by type of cash flow
6) The Six investment decision rules:
The two most popular measures/rules used to evaluate a single capital project are net present
value (NPV) and internal rate of return (IRR). But there are alternative methods that we should
examine. These rules are used to evaluate the potential profitability of an investment or project.
The Payback Period (PbP)
The Discounted Payback Period (DPbP)
Net Present Value (NPV)
The Internal Rate of Return (IRR)
The Average Accounting Rate of Return (AAR)
1

The Profitability Index (PI)
7)
Advantages & Limitations of each rule
8)
The NPV Profile (Graphical Representation)
9)
The NPV profile & areas of conflict in ranking between the
NPV & the IRR for
two Mutually Exclusive projects
10)
Which Method should be used when we have a ranking conflict? Why?
11)
What causes this conflict in ranking?
12)
NPV and its Effect on Stock Price
13)
The Practice of Capital Budgeting
14)
To reinforce your understanding of the theoretical
material learned in class, I
have prepared 13 practice
problems for your review.
Practice problem 1:
Calculate the NPV of a capital project with an initial investment of $30 million. The project
generates after - tax cash flows of $10 million at the end of Year 1, $14 million at the end of Year
2, and $18 million at the end of Year 3. The required rate of return is 10%
Practice problem 2:
2

The Yurdone Corp. wants to set up a private cemetery business. According to the CFO, Barry M
Deep, business is looking up. As a result, the cemetery project will provide
a net cash inflow of
$115,000 for the firm the first year, and the cash flows are projected to grow at a rate of 6% per
year, forever. The project requires an initial investment of $1,400,000.
a. If Yurdone requires a 13% return on such undertakings, should the cemetery business be
started?
b. The company is somewhat unsure about the assumption of a 6% growth rate in its cash flows.
At what constant growth rate would the company just break even if it still required a 13% return
on investment?
Practice problem 3:
Calculate the IRR of a capital project with an initial investment of $30 million. The project
generates after - tax cash flows of $10 million at the end of Year 1, $14 million at the end of Year
2, and $18 million at the end of Year 3. Determine whether the project should be undertaken
given that the required rate of return is 10%.
Practice problem 4:
Let's consider two projects. project A & project B. The cash flow streams for both projects are
given below. For both projects, the required rate of return is 7%. Find the NPV & IRR of each
project.
Year
0
1
2
3
NPV
IRR
A
-$350,000
$425,00
0
$0
$0
B
-$350,000
$16,000
$16,000
$466,000
The NPVs of the projects at the various discount rates are shown below:
Discount rate%
NPV (A)
NPV(B)
0.000
75,000
148,000
5.000
54,762
82,299
7.000
47.196
59,323
8.715
40,930
40,930
10.000
36,364
27,881
12.960
26,239
0
3