Questions on Capital Budgeting Techniques

1. Consider the project with initial investment of Nu. 200,000 and with the following
expected cash flows:

Year Cash flow

1 Nu. 50,000
2 Nu. 50,000
3 Nu. 200,000

a.If the discount rate is 0%, what is the project's net present value?
b.If the discount rate is 5%, what is the project's net present value?
c.What is this project's internal rate of return?
d.If the reinvestment rate is 5%, what is this project's modified internal rate of
return?
2. Consider a project costing Nu. 50,000 with the expected cash flows:

Year Cash flow

1 Nu. 50,000
2 Nu. 100,000
3 Nu. 100,000

a. What is this project's internal rate of return?

b. If the discount rate is 5%, what is this project's net present value?
3. A project requiring a Nu. 1 million investment has a profitability index of 0.96. What is
its net present value?

4. The Pacific Princess luxury cruise line is contemplating leasing an additional cruise ship
to expand service from the Hawaiian Islands to Long Beach or San Diego. A financial
analysis by staff personnel resulted in the following projections for a five-year planning
horizon:
Long Beach San Diego

Cost Nu. 2,000,000 Nu. 3,000,000

PV of expected cash flow Nu. 2,500,000 Nu. 3,600,000
@ k = 15%

a. Calculate the net present value for each service. Which is more desirable
according to the NPV criterion?
b. Calculate the profitability index for each service. Which is more desirable
according to the PI criterion?
5. Consider a project with the expected cash flows:

Year Cash flow

0 -Nu.50,000
1 +50,000
2 +100,000
3 -Nu.100,000

a. What is this project's internal rate of return?

b. If the discount rate is 5%, what is this project's net present value?
6. Suppose that your college roommate has approached you with an opportunity to lend Nu.25, 000
to her fledgling home healthcare business. The business, called Home Health Care, Inc., plans to
offer home infusion therapy and monitored in-the-home healthcare services to surgery patients in
the Birmingham, Alabama, area. Funds would be used to lease a delivery vehicle, purchase
supplies, and provide working capital. Terms of the proposal are that you would receive Nu.5,
000 at the end of each year in interest with the full Nu.25, 000 to be repaid at the end of a ten-year
period.

a. Assuming a 10% required rate of return, calculate the present value of cash flows and the
net present value of the proposed investment.
b. Based on this same interest rate assumption, calculate the cumulative cash flow of the
proposed investment for each period in both nominal and present value terms.
c. What is the payback period in both nominal and present-value terms?
d. What is the difference between the nominal and present-value payback period? Can the
present-value payback period ever be shorter than the nominal payback period?

7. There is one potential project that Company A wishes to appraise with the following
characteristics:
 An initial investment of Nu.50,000 is required during the first year.
 The project will last for four years and the cash inflows during these four years will be:
 Year 1 : Nu.15,000
 Year 2: Nu. 20,000
 Year 3: Nu. 25,000
 Year 4: Nu. 18,000
The company has a cost of capital of 15% and wishes to appraise this project and decide whether
to proceed or not.

8. You have a choice between 2 mutually exclusive investments. If you require a 15% return, which
investment should you choose:-
a. Project A, because it has a smaller initial investment.
b. Project B, because it has a higher NPV.
c. Either one, because they have the same profitability indexes.
d. Project A, because it has the higher internal rate of return.
e. Project B, because it pays back faster.
 Year End Cash Flow (amount in Nu.)
Project A Project B
Year
0 100,000 125,000
1 20000 75000
2 40000 45000
3 80000 40000
9. Coughlin Motors is considering a project with the following expected cash flows:
Year Project Cash Flow
0 - Nu. 700 million
1 200 million
2 370 million
3 225 million
4 700 million
The project's WACC is 10 percent. What is the project's discounted payback?

10. Consider the project with the following expected cash flows:

Year Cash flow

0 -Nu200,000
1 +50,000
2 +50,000
3 +Nu.200,000

a. If the discount rate is 0%, what is the project's net present value?
b. If the discount rate is 5%, what is the project's net present value?
c. What is this project's internal rate of return?
d. If the reinvestment rate is 5%, what is this project's modified internal rate of
return?

11. Consider a project with the expected cash flows:

Year Cash flow

0 -Nu.50,000
1 +50,000
2 +100,000
3 -Nu.100,000

a. What is this project's internal rate of return?

b. If the discount rate is 5%, what is this project's net present value?
 Past Paper Questions:
1. A project has an initial cost of Nu.6, 500. The cash inflows are Nu.900, Nu.2, 200, Nu.3, 600, and
Nu.4, 100 over the next four years, respectively. What is the Payback Period for the project? Different
between Pay Back Period and Average rate of return method of Capital Budgeting?
[2+3=5 Marks]

2. Bright Metals Ltd. is considering two different investment proposals, A and B. The details are as
under:

Proposal A Proposal B

Investment cost Nu. 9,500 Nu. 20,000

Estimated income
Year 1 Nu. 4,000 Nu. 8,000
Year 2 Nu. 4,000 Nu. 8,000
Year 3 Nu. 4,500 Nu. 12,000

Suggest the most attractive proposal on the basis of the NPV method considering that the future
incomes are discounted at 12%. Also find out the IRR of the two proposals.

3. Precision Instruments is considering two mutually exclusive Projects X and Y: Following

details are made available to you:

Project X Project Y

Project cost Nu. 70000 Nu. 70000

Cash inflows:
Year 1 Nu. 10000 Nu. 50000
Year 2 Nu. 20000 Nu. 40000
Year 3 Nu. 30000 Nu. 20000
Year 4 Nu. 45000 Nu.10000
Year 5 Nu. 60000 Nu.10000

Assume no residual values at the end of the fifth year. The firm’s cost of capital is 10% required.

In respect of each of the two projects, Calculate: [8 Marks]

1. Net present value, using 10% discounting

2. Internal rate of return
3. Profitability index

Which Project should be undertaken by Precision Instruments and Why?