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Discounted Cash Flows: Background Data

Background Data and Information

You are the CFO of Delta International, a manufacturer of ski bindings. You are planning your capital budget for next fiscal year and have gathered the following information:

Your investment banker indicates that if Delta issues four million dollars in bonds the expected yield will be 7 percent. If eleven million dollars are issued then the yield is expected to be 14 percent. And if seven million dollars are issued then the yield is anticipated to be 10 percent.

Delta's minimum required return on projects is seven percent. The operating managers have proposed the following projects, all of which meet the minimum required return. They include the following:

Project A will have an initial investment of two million dollars and a five-year life. During this period it is expected to generate sales of four million dollars per year and have expenses of $3,271,400 per year.

Project B is the replacement of a manual lathe with a computer driven lathe. The labor savings are expected to be four hundred and sixty thousand dollars per year over the next three years. The initial investment is one million dollars.

Project C has an IRR of 13 percent and an initial investment of 4 million dollars. Project D's initial investment is 2 million dollars which generates an IRR of 9 percent. Project E's IRR is 8 percent on an initial investment of 2 million dollars.

Assignment

1. Calculate the IRR for projects A and B. Please set these projects up in the standard NPV format shown in the lecture and show your work.

2. Complete a Marginal Cost of Capital/Discounted Cash Flows Analysis using the same table format as shown below and in the lecture:

Project Amount IRR Capital Cost Capital Remaining

@ lowest marginal cost

3. Please identify which projects should be funded that have an internal rate of return that meets or exceeds the marginal cost of capital.

Solution Preview

Project A

Year Cash Flow A
0 -2000000
1 728600
2 728600
3 728600
4 728600
5 728600
IRR 24%

Project B

Year Cash Flow ...

Solution Summary

This solution explains discounted cash flows.

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