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Capital Budgeting: A Project's Net Present Value

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Part 1
a. Consider the project with the following expected cash flows:
Year Cash Flow
0 - $550,000
1 $90,000
2 $100,000
3 $450,000

- If the discount rate is 0%, what is the project's net present value?
- If the discount rate is 4%, what is the project's net present value?
- If the discount rate is 8%, what is the project's net present value?
- If the discount rate is 10%, what is the project's net present value?
- What is this project's internal rate of return?

Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the "x" axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. connect the four points using a free hand 'smooth' curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis?

b. Consider a project with the expected cash flows:
Year Cash Flow
0 - $315,000
1 +71,000
2 +150,000
3 +$150,000

- What is this project's internal rate of return?
- If the discount rate is 0%, what is this project's net present value?
- If the discount rate is 4%, what is this project's net present value?
- If the discount rate is 8%, what is this project's net present value?
- If the discount rate is 12%, what is this project's net present value?

Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the "x" axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. connect the four points using a free hand 'smooth' curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis?

c. A project requiring a $3.3 million investment has a profitability index of 0.96. What is its net present value? (Remember: Profitability Index is defined as Present Value of the proceeds divided by the initial investment)

Part 2
Read the article linked below. Which method do you think is the better one for making capital budgeting decisions - IRR or NPV?

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Solution Summary

This response calculates a project's internal rate of return and net present value based on various discount rates.

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