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.