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Capital Budgeting at X-treme Vitamin Company

X-treme Vitamin Company is considering two investments, both of which cost $10,000. The cash flows are as follows:
Year Project A Project B
1 . . . . . . . . . . $12,000 $10,000
2 . . . . . . . . . . 8,000 6,000
3 . . . . . . . . . . 6,000 16,000
a. Which of the two projects should be chosen based on the payback method?
b. Which of the two projects should be chosen based on the net present value method? Assume a cost of capital of 10 percent.
c. Should a firm normally have more confidence in answer a or answer b?

Solution Preview

X-treme Vitamin Company is considering two investments, both of which cost $10,000. The cash flows are as follows:
Year Project A Project B
1 . . . . . . . . . . $12,000 $10,000
2 . . . . . . . . . . 8,000 6,000
3 . . . . . . . . . . 6,000 16,000
a. Which of the two projects should be chosen based on the payback method?

In Payback method, we find the tima taken to recover the initial investment. For Project A, the initial investment is 10,000. In the first year the inflow is 12,000. The inflow is higher than the initial investment, the payback is less than a year. Assuming that the folwos are evn throughout the year, we can say that the inflow is 12,000/12=1,000 ...

Solution Summary

This solution provides calculations for the capital budgeting problem at X-treme Vitamin in the attached Excel file.

$2.19