Sub: Accounts Topic: CapitalBudgeting

Question:
Henn Corp, Ltd. is examining two investment projects as a part of its expansion plan for the
coming year. These two projects are not mutually exclusive. The cost of Project A is $12,950
while the second project (B) is expected to cost $18,625. Henn's cost of capital (required rate of
return) is 11.5 %. Expected annual cash flows are projected to be as follows:

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Year project A Project B

1 3,250.00 6,850.00

2 3,250.00 6,850.00

3 3,250.00 6,850.00

4 3,250.00 6,850.00

5 3,250.00 6,850.00

Each project will last an estimated 5 years with no remaining significant scrap value. Determine
the IRR and the NPV for each of these two projects. What should Henn Corp decide about each
proposed project

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Sub: Accounts Topic: CapitalBudgeting

Solution:

Initial cost
Project A $12,950
Project B $18,625
Cost of capital (required
rate of return) 11.50%

Details of Cash flow

Year Project A Project B
1 $3,250 $6,850
2 $3,250 $6,850
3 $3,250 $6,850
4 $3,250 $6,850
5 $3,250 $6,850

Project A
Computation of NPV and
IRR
Particulars 0 1 2 3 4 5
Initial cost -$12,950 $0 $0 $0 $0 $0
Cash inflows 0 $3,250 $3,250 $3,250 $3,250 $3,250
Net cash flows -$12,950 $3,250 $3,250 $3,250 $3,250 $3,250
Discounting factor
@11.50% 1.0000 0.8969 0.8044 0.7214 0.6470 0.5803
-
Discounted net cash flows $12,950.00 $2,914.80 $2,614.17 $2,344.55 $2,102.73 $1,885.86

NPV -$1,087.90

IRR 8.08%

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 Sub: Accounts Topic: CapitalBudgeting

Project B
Computation of NPV and
IRR
Particulars 0 1 2 3 4 5
Initial cost -$18,625 $0 $0 $0 $0 $0
Cash inflows $0 $6,850 $6,850 $6,850 $6,850 $6,850
Net cash flows -$18,625 $6,850 $6,850 $6,850 $6,850 $6,850
Discounting factor
@11.50% 1.0000 0.8969 0.8044 0.7214 0.6470 0.5803
-
Discounted net cash flows $18,625.00 $6,143.50 $5,509.86 $4,941.58 $4,431.91 $3,974.81

NPV $6,376.66

IRR 24.47%

The NPV for Project A is negative. So project A should not be accepted. The NPV for Project B is
positive, as such Project B should be accepted

** End of the Solution **

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