# Finance: Capital budgeting.

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Part 1. Capital Budgeting Practice Problems

a. Consider the project with the following expected cash flows:

Year Cash flow

0 - $400,000

1 $100,000

2 $120,000

3 $850,000

If the discount rate is 0%, what is the project's net present value?

If the discount rate is 2%, what is the project's net present value?

If the discount rate is 6%, what is the project's net present value?

If the discount rate is 11%, what is the project's net present value?

What is this project's modified 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?

[You can't upload the graph unto Coursenet. Look at the graph you draw and write a short paragraph stating what the graph 'shows"]..

b. Consider a project with the expected cash flows:

Year Cash flow

0 -$815,000

1 $141,000

2 $320,000

3 $440,000

What is this project's internal rate of return?

If the discount rate is 1%, 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 10%, what is this project's net present value?

If the discount rate is 18%, 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?

[You can't upload the graph unto Coursenet. Observe the graph and write a short paragraph stating what the graph 'shows

c. A project requiring a $4.2 million investment has a profitability index of 0.94. 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. Then write a paper answering the following question:

Which method do you think is the better one for making capital budgeting decisions - IRR or NPV?

Defend your answer with references to the background materials.

Please read the following article which is available in Proquest:

Internal rate of return

Computerworld; Framingham; Feb 17, 2003; Gary H Anthes

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##### Solution Summary

The problem set deals with estimating values under capital budgeting: Net present value (NPV), IRR (Internal rate of return) etc.

###### Education

- B. Sc., University of Nigeria
- M. Sc., London South Bank University

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