Problem Set on Capital Budgeting
1. Project K has a cost of $52,125, its expected net cash flows are $12,000 per year for 8 years, and its cost of capital is 12 percent.
a. According to the payback period criterion should the project be accepted?
b. According to the NPV criterion should the project be accepted?
c. According to the IRR criterion should the project be accepted?
2. Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year’s capital budget. The projects are independent. The cash outlay for the truck is $17,100, and that for the pulley system is $22,430. The firm’s cost of capital is 14 percent. After-tax cash flows, including depreciation, are $5,100 per year for five years for the truck and $7,500 per year for five years for the pulley. Calculate the IRR and the NPV for each project and indicate the correct accept/reject decision for each.
3. Project S costs $15,000 and is expected to produce cash flows of $4,500 per year for 5 years. Project L costs $37,500 and is expected to produce cash flows of $11,100 per year for 5 years. Calculate the two projects’ NPVs and IRRs, assuming a cost of capital of 14 percent. Which project should be selected, assuming they are mutually exclusive, using each ranking method? Which should actually be selected?
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