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10-1 CHAPTER 10 The Basics of Capital Budgeting Problem solving Lidija Dedi

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10-2 Problem 1: Projects X i Y have following cash flows YearProject XProject Y 0(40.000) 16.00010.000 26.00010.000 38.00010.000 4 5 620.00010.000

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10-3 Calculate for projects X and Y: Payback period Discounted payback period Net present value Internal rate of return The firm’s cost of capital is 10 %

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10-4 a) Payback period for project X GodinaProjekt X 0(40.000) 16.000 2 38.000 410.000 5 620.000

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10-5 YearProject XCumulative cash flows 16.000 2 12.000 38.00020.000 410.00030.000 510.00040.000 620.000 Payback period = 5 years a) Payback period for project X

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10-6 Payback period for project Y

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10-7 b) Discounted payback period

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10-8 Discounted payback period for X YearProject X 0(40.000) 16.000 2 38.000 410.000 5 620.000

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10-9 YearProject X PVIF(10%) 0(40.000)1,0000 16.0000,9091 26.0000,8264 38.0000,7513 410.0000,6830 510.0000,6209 620.0000,5645 Discounted payback period for X

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10-10 YearProject X PVIF (10%)Discounted cash flows 0(40.000)1,0000(40.000) 16.0000,90915.454,60 26.0000,82644.958,40 38.0000,75136.010,40 410.0000,68306.830,00 510.0000,62096.209,00 620.0000,564511.290,00 Discounted payback period for X

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10-11 YearDiscounted Cash Flows Cumulative discounted CF 0(40.000) 15.454,60 24.958,4010.413,00 36.010,4016.423,40 46.830,0023.253,40 56.209,0029.462,40 611.290,00 40.000-29.462,40 =10.537,60 10.537,60/11.290 =0,93 Discounted payback period = 5,93 years Discounted payback period for X

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10-12 Discounted payback period for project Y YearProject Y 0(40.000) 110.000 2 3 4 5 6

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10-13 YearProject Y PVIF (10%) 0(40.000)1,0000 110.0000,9091 210.0000,8264 310.0000,7513 410.0000,6830 510.0000,6209 610.0000,5645 Discounted payback period for project Y

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10-14 Discounted payback period for project Y YearProject Y PVIF (10%)Discounted CF 0(40.000)1,0000(40.000) 110.0000,90919.090,10 210.0000,82648.264,00 310.0000,75137.513,00 410.0000,68306.830,00 510.0000,62096.209,00 610.0000,56455.645,00

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10-15 YearDiscounted CFCumulative discounted CF 0 (40.000) 1 9.090,10 2 8.264,00 17.354,10 3 7.513,00 24.867,10 4 6.830,00 31.697,10 5 6.209,00 37.906,10 6 5.645,00 2.093,90/5.645,00 = 0,37 Discounted payback period = 5,37 years Discounted payback period for project Y

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10-16 c) Net Present Value for project X Year Project X PVIF (10%)Discounted CF 0 (40.000)1,0000(40.000) 1 6.0000,90915.454,60 2 6.0000,82644.958,40 3 8.0000,75136.010,40 4 10.0000,68306.830,00 5 10.0000,62096.209,00 6 20.0000,564511.290,00 CF 40.752,40 IC(40.000) NET PRESENT VALUE = 752,40

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10-17 Net Present Value for project Y Project Y – equal Cash Flows

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10-18 c) Iternal Rate of Return X Year Project X PVIF (10%)Discounted CF 0 (40.000)1,0000(40.000,00) 1 6.0000,90915.454,60 2 6.0000,82644.958,40 3 8.0000,75136.010,40 4 10.0000,68306.830,00 5 10.0000,62096.209,00 6 20.0000,564511.290,00 CF 40.752,40 IC(40.000) NET PRESENT VALUE = 752,40

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10-19 YearProject X CF PVIF (10%) Factor Amount PVIF (11%) Factor Amount 16.0000,90915.454,600,90095.405,40 26.0000,82644.958,400,81164.869,60 38.0000,75136.010,400,73125.849,60 410.0000,68306.830,000,65876.587,00 510.0000,62096.209,000,59355.935,00 620.0000,564511.290,000,534610.692,00 NT 40.752,4039.338,60 IT(40.000) ČISTA SADAŠNJA VRIJEDNOST 752,40- 661,40 c) Iternal Rate of Return X

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10-20 Interpolation

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10-21 Internal Rate of Return for project Y Equal Cash Flows INTERPOLATION

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10-22 Problem 2: ABC company is considering a project with the following expected cash flows: YearProject Cash Flow 0- 700 1200 2370 3225 4700

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10-23 - The project’s WACC is 10 percent - What is the project’s payback period and discounted payback

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10-24 Problem 3: You are considering the purchase of an investment that would pay you $5.000 per year for Years 1-5, $3.000 per year for Years 6-8, and $2.000 per year for Years 9 and 10 If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?

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10-25 Problem 4: ABC Inc. requires a new machine. Two companies have submitted bids, and you have been assigned the task of choosing one of the machines. Cash flow analysis indicates the following: YearMachine A (CF)Machine B (CF) 0- 2.000 10832 20 30 43.877832

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10-26 What is the internal rate of return for each machine?

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10-27 Problem 5: The firm’s project has a cost of $275.000 and is expected to provide after-tax annual cash flows of $73.306 for eight years. The firm’s management is uncomfortable with the IRR reinvestment assumption and prefers the modified IRR approach. You have calculated a cost of capital for the firm of 12 percent. What is the project’s MIRR?

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10-28 Problem 6: A company is analyzing two mutually exclusive projects, S and L, whose cash flows are shown below: 1.000- 1.100 0 21 350 3 50 S L 0- 1.100 3001.500 Years

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10-29 The company cost of capital is 12 percent What is the regular IRR of the better project, that is, the project which the company should choose if it wants to maximize its stock price?

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10-30 Problem 7: ABC corporation is considering a project with the following cash flows: YearProject Cash Flow (000) 0? 11.000 21.500 32.000 42.500

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10-31 The project has a simple payback period of exactly two years. The project’s cost of capital is 12% What is the project’s modified internal rate of return (MIRR)?

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10-32 Problem 8: Alpha Hotels is considering two mutually exclusive projects, Project A and project B. The cash flows from the projects are summarized below: year01234 Project A- 200.00050.000 80.000100.000 Project B- 100.00025.000 50.000

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10-33 The two projects have the same risk. At what cost of capital would the two projects have the same net present value?

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10-34 Problem 9: ABC corporation estimates that its cost of capital is 11 percent The company is considering two mutually exclusive projects whose after- tax cash flows are as follows:

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10-35 YearProject S Cash flow Project L Cash Flow 0- 3.000- 9.000 12.500- 1.000 21.5005.000 31.5005.000 4- 5005.000 What is the modified internal rate of return of the project with highest NPV?

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