# Capital Budgeting

Brutus can purchase equipment on sale for $4,300. The asset has a three year life and will produce a cash flow of $1200 in each of the first and second years, and $3000 in the third year. The interest rate is 12 percent.

Calculate the payback period.

Calculate the IRR. Should the project be taken?

Compute the project's NPV.

Consider two mutually exclusive R&D projects that XYZ, a chip manufacturer, is considering. Assume the corporate discount rate is 15 percent and the minimum acceptable IRR is 25 percent.

Project A: Server CPU 0.13 micron processing project. By shrinking the die size to 0.13 micron, XYZ will be able to offer server CPU chips with lower power consumption and heat generation, meaning faster CPUs.

Project B: New telecom chip project. Entry into this industry will require introduction of a new chip for cell phones. The know-how will require large upfront capital, but success of the project will lead to larger cash flows later on.

Year A B

0 -$100,000 -$200,000

1 50,000 60,000

2 50,000 60,000

3 40,000 60,000

4 30,000 100,000

5 20,000 200,000

SUM $ 90,000 $ 280,000

a. Calculate the NPV, IRR, incremental IRR, and PI for both projects.

b. Discuss the financial implications associated with these two projects.

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#### Solution Summary

The solution explains the calculation of NPV, IRR and taking the accept/reject decision