Finance: Assessing Investments
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Growth Enterprises, Inc. (GEI) has $40 million that it can invest in any or all of the four capital investment projects, which have cash flows as shown in Table A below.
Type of
Project Type of Cash Flow Year 0 Year 1 Year 2 Year 3
A Investment (10,000)
Revenue 21,000
Operation Expenses 11,000
B Investment (10,000)
Revenue 15,000 17,000
Operation Expenses 5,833 7,833
C Investment (10,000)
Revenue 10,000 11,000 30,000
Operation Expenses 5,555 4,889 15,555
D Investment (10,000)
Revenue 30,000 10,000 5,000
Operation Expenses 15,555 5,555 2,222
Each of the projects is considered to be of equivalent risk. The investment will be depreciated to zero on a straight-line basis for tax purpose.
GEI's marginal corporate tax rate on taxable income is 40%. None of the projects will have any salvage value at the end of their respect lives.
For purposes of analysis, it should be assumed that all cash flows occur at the end of the year in question.
A. Rank GEI's four projects according to the following four commonly used capital budget criteria:
1) Payback period
2) Accounting return on investment. For purposes of this exercise, the accounting return on investment should be defined as follows:
Average annual after-tax profits
(required investment)/2
3) Internal rate of return
4) Net present value, assuming alternately a 10% discount rate and a 35% discount rate
B. Why do the ranking differ? What does each technique measure and what assumptions does it make?
C. If the projects are independent of each other, which should be accepted? If they are mutally exclusive (i.e one and only one can be accepted), which one is the best?
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Solution Summary
This solution answers various questions regarding investments in Excel.
Education
- MBA, Indian Institute of Finance
- Bsc, Madras University
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