Professional Documents
Culture Documents
Capital Budgeting
ACCT 2200
PROFESSOR THOMAS BOURVEAU
Present
value of
cash inflows
Present
value of
cash outflows
90
IRR
18%
55
(1 +
> 10%
IRR)1
60.50
(1 + IRR)2
One important note about the IRR function is that you must
include the original cash outflow in the calculation.
Application
A local company, Lester Inc. has a minimum required rate of
return / cost of capital of 8% per year. The company is considering
investing in a robotic project that costs HKD68,337 and is expected
to generate cash flows of approximately HKD 27,000 per year for
the next three years. The approximate internal rate of return of
this project is:
A. 8%
B. 9%
C. 10%
D. Less than the required 8%
Profitability Index
The profitability index is the ratio of a projects benefits (measured
by the present value of the future cash flows) to its costs (or
required investment).
Exercise E11-7
Your friend Harrold is trying to decide whether to buy or lease his
next vehicle. He has gathered information about each option but is
not sure how to compare the alternatives. Purchasing a new
vehicle cost $26,500, and Harrold expects to spend about $500 per
year in maintenance costs. He would keep the vehicle for five
years and estimate the salvage value to be $10,500. Alternatively,
he could lease the same vehicle for five years at a cost of $3,480
per year, including maintenance. Assume a discount rate of 10
percent.
Prioritizing Independent
Projects
The profitability index is used to prioritize
capital investment projects.
Profitability
Index
Present Value of
Future Cash flows
Initial
Investment
Prioritizing Independent
Projects
Application
Lester Inc. just raised HKD1,000,000 from investors in Hong Kong to
fund the creation of a new robot with a cost of capital of 10%. The CEO
of the company hesitates between two different mutually exclusive
projects. Both of them requires an initial cash outflow of HKD1,000,000
but have the following cash flow patterns:
Year 1
Year 2
Year 3
Year 4
Year 5
Total
Project A
800,000
600,000
400,000
200,000
100,000
2,100,000
Project B
100,000
200,000
400,000
600,000
800,000
2,100,000
Application
Sai Kung Transportation is considering the purchase
of a new junk carrier for HKD8 million. The forecast
revenues are HKD5 million a year and total operating
costs are HKD4 million. A major ret costing HKD2
million will be required after both the fth and tenth
years. After 15 years, the ship is expected to be sold for
scrap at HKD1.5 million.
Required: If the discount rate is 8 percent, what is the
NPV of investing in the new ship?