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Capital budgeting

Project P, the firm is considering sponsoring a pavilion at the upcoming World's fair. The pavilion would cost $800,000 and it is expected to result in $5million o incremental cash inflows during its 1 year of operation. However, it would then take another year, and $5million of cost, to demolish the sit and return it to its original condition. Thus, Project P's expected cash flows look like this (in millions of dollars)
0 1 2
- $0.8 $5.0 -$5.0
The project is estimated to be of average risk, so its WACC is 10%.
(1) What is Project P's NPV? What is its IRR? Its MIRR?
(2) Draw project P's NPV profile. Does project P have normal or non-normal cash flows? Should this project be accepted? Explain.
(3) What is the difference between the regular and discounted payback methods?
(4) What are the two main disadvantages of discounted payback? Is the payback method of any real usefulness in capital budgeting decisions? Explain.
(5) What is the underlying cause of ranking conflicts between NPV and IRR?
(6) What is the investment rate assumption? And how does it affect the NPV versus IRR conflict?
(7) Which method is best? Why?

Solution Preview

Please see the Excel attachment for complete details.

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Written Assignment.
Project P, the firm is considering sponsoring a pavilion at the upcoming World' fair. The pavilion would cost $800,000 and it is expected to result in $5million o incremental cash inflows during its 1 year of operation. However, it would then take another year, and $5million of cost, to demolish the sit and return it to its original condition. Thus, Project P's expected cash flows look like this (in millions f dollars)
0 1 2
- $0.8 $5.0 -$5.0
The project is estimated to be of average risk, so its WACC is 10%.

(1) What is Project P's NPV? What is its IRR? Its MIRR?
Please see the excel file

(2) Draw project P's NPV profile. Does project P have normal or non-normal cash flows? Should this project be accepted? Explain.
Please see the excel file.

Project has non-normal cash flows since the sign changes again in year 2
The project should not be accepted as it has a negative NPV at 10% discounting rate

(3) What is the difference ...

Solution Summary

The solution explains the calculation of patyback, NPV and IRR and the preparation of NPV profile

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