14 May Fin550 Capital Budgeting SOUTHERN NEW HAMPSHIRE UNIVERSITY Term 17TW1 FIN550: Chapter 10 Handout (Capital Budgeting) INSTRUCTOR: Dr. Gary P. Tripp Your Boss Has Just Handed You The Following Estimated Cash Flows For Two Proposed Projects. Pro
Fin550 Capital Budgeting
SOUTHERN NEW HAMPSHIRE UNIVERSITY
Term 17TW1
FIN550: Chapter 10 Handout (Capital Budgeting) INSTRUCTOR: Dr. Gary P. Tripp
Your boss has just handed you the following estimated cash flows for two proposed projects. Project X involves adding a new product to the firm’s existing product lines. Since it would take some time to build up a market for the new product, the expected cash flows will gradually rise over time. Product Y involves a modification to an existing product, and thus its cash flows are expected to decrease over time. Both projects have 3-year lives.
Here are the net cash flow estimates (in millions of dollars):
Expected Net Cash Flows
Year Project X Project Y
0 ($250) ($250)
1 25 175
2 150 125
3 200 50
Your boss informs you that depreciation, salvage values, net working capital requirements and tax effects are included in all of the above estimated cash flows. Subjective risk assessments have been made for both projects, and the risk characteristics are similar to the firm’s typical project. Finally, the overall cost of capital (i.e., WACC) is 10 percent.
Accept or Reject Accept or Reject
Method
Project
X
Project
Y
Independ.
X
Mutually Excl. X
Independ.
Y
Mutually
Excl. Y
Payback
Period
Discounted Payback
Period
Net Present
Value
IRR
Profit. Index
Modified
IRR
TABLE OF NPVs (IN DOLLARS) FOR PROJECTS X & Y
Cost of Capital (WACC)
Net Present Value: X
Net Present Value: Y
0%
5%
10%
15%
20%
NET PRESENT VALUE PROFILES: NPVX AND NPVY
Note: The cross-over rate occurs at 8.68% for Projects X & Y.
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