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# Capital Budgeting Models

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The manufacturing department of Holmes Manufacturing Company must choose from six capital budgeting proposals outlined below. The department is subject to capital rationing and it has a budget ceiling of 1,000,000. The company's cost of capital is 15%. Using the criteria of IRR and NPV below, which projects should the department choose?

Project Initial Cost IRR NPV
1 \$200,000 19% \$100,000
2 \$400,000 17% 20,000
3 \$250,000 16% 60,000
4 \$200,000 12% -5,000
5 \$150,000 20% 50,000
6 \$400,000 15% 150,000

#### Solution Preview

NPV Criteria

Highest NPV is \$150,000 for Project 6. It should be selected first. Capital employed till now=\$400,000

Next highest NPV is \$100,000 for Project 1. It should be selected next. Capital employed till now=\$400,000+\$200,000=\$600,000

Next highest NPV is \$60,000 for Project 3. It should be selected next. Capital employed till ...

#### Solution Summary

Solution selects the appropriate projects based upon NPV and IRR models.

\$2.19

## Make capital budgeting decisions utilizing various capital budgeting models.

Make capital budgeting decisions utilizing various capital budgeting models.

1. Payback method
2. Net Present Value method
3. Internal Rate of Return method

Muscatel, Inc. is evaluating whether to build a bridge that will take two years to construct, or use a ferry to transport ore across a river. The cost of each alternative is a follows:

Bridge Ferry
Investment year 0 \$4,000,000 \$1,000,000
Annual revenue
Year 1 0 \$750,000
Year 2 0 \$750,000
Years 3-10 \$1,500,000 \$750,000
Annual operating cost \$250,000 \$100,000
Cost of capital 10% 10%

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