Explore BrainMass
Share

# Capital Budgeting Methods

This content was STOLEN from BrainMass.com - View the original, and get the already-completed solution here!

Given the following estimated CF (in millions of dollars) for a project with a required rate of return of 9% and a reinvestment rate of 13%:

Period: t=0 t=1 t=2 t=3 t=4
----------------------------------------------------------
Cash Flow: (350) 125 75 200 125

a. Compute PB
b. Compute DPB
c. Compute NPV
d. Compute IRR
e. Compute MIRR
f. Compute MNPV

Where does the 9% required rate of return and the 13% re-investment rate figure into the problem/equation?

#### Solution Preview

Please refer attached file for better clarity of tables.

a. Compute PB

Period Cash flow Cumulative
t Ct cash flow
1 125 125
2 75 200
3 200 400
4 125 525

We find that initial investment of \$350 is recovered in 3rd year.
Amount to be recovered in 3rd year=TB=350-200=\$150.00
Total cash flow in 3rd year=TC=\$200.00
Payback period=2+(TB/TC)=2.75 Years

b. Compute DPB

Period Cash flow PV @9% Cumulative
t Ct Ct/(1+9%)^t PV
1 125 114.68 114.68
2 75 63.13 ...

#### Solution Summary

The solution describes the steps to calculate PB, DPB, NPV, IRR, MIRR and MNPV in the given case.

\$2.19

## Capital Budgeting Techniques: IRR Method

See the attached file for full problem.

A particular operation at a manufacturing company costs \$100,000 per year in labor costs. A proposal is made to automate this operation with a robot. The cost of the robot, the controller, and ancillary systems is \$200,000 installed. It has a 10-year life and no market value at the end of the ten years. The robot will save all of the \$100,000 annual labor costs but will require \$64,000 per year in maintenance and support. It will be depreciated over the 10-year life using Straight Line (SL) depreciation. The company has an effective income tax rate of 40% and must earn 8% after taxes on projects to consider them viable.

(a) Use the Internal Rate of Return (IRR) method to determine if the robot acquisition is justifiable.

(b) Use MACRS with a seven-year recovery period and determine the new IRR.

If your IRR in part (b) is NOT greater than 8%, please give me a detailed explanation as to why this makes sense to you.
Why is the IRR in part (b) larger than in part (a)? (If you happened to get smaller, then please re-work them.)

View Full Posting Details