CAPITAL BUDGETING
The three projects identified below should be used to answer the next 4 questions. Each project represents an investment opportunity to an organization. The relevant rate of interest, called the cost of capital, is 3.5%.
PROJECT A PROJECT B PROJECT C
CF0 -$20,000 -$15,000 -$50,000
CF1 $ 4,500 $ 500 $ 6,000
CF2 $ 4,000 $ 500 $ 6,000
CF3 $ 3,500 $ 750 $ 6,000
CF4 $ 3,000 $ 1,000 $ 6,000
CF5 $ 2,500 $ 1,500 $ 6,000
CF6 $ 2,000 $ 2,000 $ 6,000
CF7 $ 1,500 $ 2,500 $ 6,000
CF8 $ 1,000 $ 3,000 $ 6,000
CF9 $ 750 $ 3,500 $ 6,000
CF10 $ 250 $ 4,000 $ 6,000
1. What are the returns on investments for each project? You will need to calculate the internal rates of return.
1a. A. 3.31% - 3.40%
B. 3.41% - 3.50%
C. 3.51% - 3.60%
D. 3.61% - 3.70%
E. 3.71% - 3.80%
F. None of the above.
1b. A. 3.31% - 3.40%
B. 3.41% - 3.50%
C. 3.51% - 3.60%
D. 3.61% - 3.70%
E. 3.71% - 3.80%
1c. A. 3.31% - 3.40%
B. 3.41% - 3.50%
C. 3.51% - 3.60%
D. 3.61% - 3.70%
E. 3.71% - 3.80%
F. None of the above.
2. Calculate the net present values for each project.
2a. A. ($219) - ($120)
B. ($119) - ($20)
C. ($19) - $80
D. $81 - $180
E. $181 - $280
F. None of the above.
2b. A. ($219) - ($120)
B. ($119) - ($20)
C. ($19) - $80
D. $81 - $180
E. $181 - $280
F. None of the above.
2c. A. ($219) - ($120)
B. ($119) - ($20)
C. ($19) - $80
D. $81 - $180
E. $181 - $280
F. None of the above.
3. Your boss has told you that she believes Project B is the best because it has the greatest summed positive cash flow (i.e., $19,250) relative to its initial cost (($19,250 -$15,000) / 15,000 = 28%). She believes the next best is Project C, with a net positive cash flow to cost of 20% (($60,000 - $50,000) / $50,000); Project A is the least favorable at 15%.
3a. Is there a flaw in her thinking?
A. No, her finding is consistent with the time value of money analysis.
B. No, her methodology is valid along with the time value of money.
C. Yes, her methodology is not a part of a valid TVM analysis.
D. Yes, she should use (total positive flows / cost).
E. None of the above.
3b. If so, how should the projects be ranked in terms of favorability?
A. A is best, then B, with C being worst.
B. B is best, then C, with A being worst.
C. C is best, then A, with B being worst.
D. A is best, then C, with B being worst.
E. None of the above.
4. What happens if the cost of capital, due to a worsening economy, drops to 2.5%? Does the profitability order of the projects change?
A. Yes: order should now be A, B, C.
B. Yes: order should now be B, C, A.
C. Yes: order should now be C, B, A.
D. Yes: order should now be A, C, B.
E. No.
5. Consider cash flows that have multiple periods per year. Option 1 has quarterly periods and Option 2 has semi-annual periods. If you invest $10,000 today in each option and each option pays out $2,800 total per year, what are the following values given a required annual rate of 5%?
5a. IRR of Option 1
A. 1.00% - 1.99%
B. 2.00% - 2.99%
C. 3.00% - 3.99%
D. 4.00% - 4.99%
E. 5.00% - 5.99%
F. None of the above.
5b. IRR of Option 2
A. 1.00% - 1.99%
B. 2.00% - 2.99%
C. 3.00% - 3.99%
D. 4.00% - 4.99%
E. 5.00% - 5.99%
F. None of the above.
5c. NPV of Option 1
A. $0 - $24
B. $25 - $49
C. $50 - $74
D. $75 - $99
E. $100 - $124
F. None of the above.
5d. NPV of Option 2
A. $0 - $24
B. $25 - $49
C. $50 - $74
D. $75 - $99
E. $100 - $124
F. None of the above.
5e. Would it preferable to receive daily payments rather than quarterly or semi-annually?
A. Daily is preferred
B. Semi-annually is preferred
C. Monthly is preferred
D. Quarterly is preferred
E. Annually is preferred