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Capital Budgeting Investment Decisions

A firm's cost of capital is 12 percent. The firm has three investments to choose among; the cash inflows of each are as follows:

Cash Inflows
A B C
YEAR 1 395 0 1241
YEAR 2 395 0 0
YEAR 3 395 0 0
YEAR 4 0 1749 0

Each investment requires a $1,000 cash outlay, and investment B and C are mutually exclusive.
(a) Which investment(s) should the firm make according to the net present values? Why?
(b) Which investments(s) should the firm make according to the internal rates of return? Why?
(c) If all funds are reinvested at 15 percent, which investment(s) should the firm make? Would your answer be different if the reinvestment rate were 12 percent?

Solution Preview

Please refer attached file for better clarity of tables.

(a) Which investment(s) should the firm make according to the net present values? Why?
Project A
Year,n Cash Flow, Cn PV =Cn/(1+12%)^n
0 -1000 -1000.00
1 395 352.68
2 395 314.89
3 395 281.15
4 0 0.00
NPV -51.28

Project B
Year , n Cash Flow, Cn PV =Cn/(1+12%)^n
0 -1000 -1000.00
1 0 0.00
2 0 0.00
3 0 0.00
4 1749 1111.52
NPV 111.52

Project B
Year , n Cash Flow, Cn PV =Cn/(1+12%)^n
0 -1000 -1000.00
1 1241 1108.04
2 0 0.00
3 0 0.00
4 0 0.00
NPV 108.04

Project A has negative NPV, it should be rejected.
Since Project B and Project C are mutually ...

Solution Summary

Solution describes the steps to calculate NPV, IRR and MNPV for each of the given projects. IRR is calculated by using suitable function/s in MS Excel.

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