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Capital Budgeting and TVM concepts

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1. Starlight, Inc. must choose between two asset purchases. The annual rate of return and related probabilities given below summarize the firm's analysis.
Asset A Asset B
Rate of Return Probability Rate of Return Probability
8% 40% 7% 30%
13% 50% 17% 50%
18% 10% 27% 20%

For each project compute: The expected rate of return.

2. The Happy Puppy Company has compiled the following data for adding a new line of pets to their stores. What is the net present value of the investment? The initial investment in the project is $48,000. The firm's cost of capital is 12%, however projects in this risk class have a 14% required rate of return. The risk-free rate is 8%.

Year Cash Inflow
1 $23,000
2 19,000
3 15,000
4 13,000
5 $12,000

3)If you want to have $750,000 for retirement in 20 years and have only $100,000 saved today, how much do you need to put away at the end of each year until retirement if your assets can earn 8% per year?

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Solution Preview

Please refer attached file for better clarity of tables.

Asset A Asset B
Rate of return, ra Probability, pa pa*ra Rate of return, rb Probability, pb pb*rb
8% 40% 0.0320 7% 30% 0.0210
13% 50% 0.0650 17% 50% 0.0850
18% 10% 0.0180 27% 20% ...

Solution Summary

There are three problems. solution to first problem describes the steps to calculate expected return. Solution to second problem depicts the methodology to calculate NPV. Solution to third problem explains the calculate annual amount of savings that will be needed to meet the given financial objective.

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Time value of money (TVM) is a very important concept. Why is it important for those participating in the capital budgeting process?

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