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Comparison of Capital Budgeting Techniques: The Dilemma at Day-Pro

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Comparison of Capital Budgeting Techniques

The Dilemma at Day-Pro

The Day-Pro Chemical Corporation, established in 1995, has managed to earn a consistently high rate of return on its investments. The secret of its success has been the strategic and timely development) manufacturing, and marketing of innovative chemical products that have been used in various industries......

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l. Calculate the Payback Period of each project. Explain what argument Tim should make to show that the Payback Period is not appropriate in this case.

2. Calculate the Discounted Payback Period (DPP) using l 0% as the discount rate. Should Tim ask the Board to use DPP as the deciding factor? Explain.

3. If management prefers to have a 40% accounting rate of return, which project would be accepted? What is wrong with this decision?

4. Calculate the two projects' IRR. How should Tim convince the
Board that the IRR measure could be misleading?

5. Calculate the NPV profiles for the two projects and explain the relevance of the crossover point. How should Tim convince the Board that the NPV method is the way to go?

6. Explain how Tim can show that the Modified Internal Rate of Return (MIRR) is the more realistic measure to use in the case of mutually exclusive projects.

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Solution Summary

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Problems with Payback Period
It ignores time value of money
it ignores cash flows after payback period
In case of synthethic resin bulk of cash flows are received after the pay back period.
Whereas in case of Epoxy resin bulk of cash flows is received before the payback period. Hence comparing the two based on payback period is not correct
Payback is more appropriate when liquidity is a problem which is not true in case of day pro. hence payback should not be used for comparison.

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See the attached file for complete help:

Problems with Payback Period
It ignores time value of money
it ignores cash flows ...

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