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Practice Question On Capital Budgeting
Practice Question On Capital Budgeting
Practice Question On Capital Budgeting
1. Consider the project with initial investment of Nu. 200,000 and with the following
expected cash flows:
a.If the discount rate is 0%, what is the project's net present value?
b.If the discount rate is 5%, what is the project's net present value?
c.What is this project's internal rate of return?
d.If the reinvestment rate is 5%, what is this project's modified internal rate of
return?
2. Consider a project costing Nu. 50,000 with the expected cash flows:
4. The Pacific Princess luxury cruise line is contemplating leasing an additional cruise ship
to expand service from the Hawaiian Islands to Long Beach or San Diego. A financial
analysis by staff personnel resulted in the following projections for a five-year planning
horizon:
Long Beach San Diego
a. Calculate the net present value for each service. Which is more desirable
according to the NPV criterion?
b. Calculate the profitability index for each service. Which is more desirable
according to the PI criterion?
5. Consider a project with the expected cash flows:
a. Assuming a 10% required rate of return, calculate the present value of cash flows and the
net present value of the proposed investment.
b. Based on this same interest rate assumption, calculate the cumulative cash flow of the
proposed investment for each period in both nominal and present value terms.
c. What is the payback period in both nominal and present-value terms?
d. What is the difference between the nominal and present-value payback period? Can the
present-value payback period ever be shorter than the nominal payback period?
7. There is one potential project that Company A wishes to appraise with the following
characteristics:
An initial investment of Nu.50,000 is required during the first year.
The project will last for four years and the cash inflows during these four years will be:
Year 1 : Nu.15,000
Year 2: Nu. 20,000
Year 3: Nu. 25,000
Year 4: Nu. 18,000
The company has a cost of capital of 15% and wishes to appraise this project and decide whether
to proceed or not.
8. You have a choice between 2 mutually exclusive investments. If you require a 15% return, which
investment should you choose:-
a. Project A, because it has a smaller initial investment.
b. Project B, because it has a higher NPV.
c. Either one, because they have the same profitability indexes.
d. Project A, because it has the higher internal rate of return.
e. Project B, because it pays back faster.
Year End Cash Flow (amount in Nu.)
Project A Project B
Year
0 100,000 125,000
1 20000 75000
2 40000 45000
3 80000 40000
9. Coughlin Motors is considering a project with the following expected cash flows:
Year Project Cash Flow
0 - Nu. 700 million
1 200 million
2 370 million
3 225 million
4 700 million
The project's WACC is 10 percent. What is the project's discounted payback?
10. Consider the project with the following expected cash flows:
a. If the discount rate is 0%, what is the project's net present value?
b. If the discount rate is 5%, what is the project's net present value?
c. What is this project's internal rate of return?
d. If the reinvestment rate is 5%, what is this project's modified internal rate of
return?
2. Bright Metals Ltd. is considering two different investment proposals, A and B. The details are as
under:
Proposal A Proposal B
Suggest the most attractive proposal on the basis of the NPV method considering that the future
incomes are discounted at 12%. Also find out the IRR of the two proposals.
Project X Project Y
Cash inflows:
Year 1 Nu. 10000 Nu. 50000
Year 2 Nu. 20000 Nu. 40000
Year 3 Nu. 30000 Nu. 20000
Year 4 Nu. 45000 Nu.10000
Year 5 Nu. 60000 Nu.10000
Assume no residual values at the end of the fifth year. The firm’s cost of capital is 10% required.