### Part 1. Capital Budgeting Practice Problems

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

```     Year	             Cash flow
0	           -\$400,000
1                    \$100,000
2                    \$120,000
3                    \$850,000
```
• If the discount rate is 0%, what is the project’s net present value?
• If the discount rate is 2%, what is the project’s net present value?
• If the discount rate is 6%, what is the project’s net present value?
• If the discount rate is 11%, what is the project’s net present value?
• With a cost of capital of 5%, what is this project’s modified internal rate of return?

Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the “x” axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. connect the four points using a free hand ‘smooth’ curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis?

[ Look at the graph you draw and write a short paragraph stating what the graph ‘shows”]..

b. Consider a project with the expected cash flows:

`    Year                    Cash flow       0                   -\$815,000       1                    \$141,000       2                    \$320,000       3                    \$440,000`
• What is this project’s internal rate of return?
• If the discount rate is 1%, what is this project’s net present value?
• If the discount rate is 4%, what is this project’s net present value?

• If the discount rate is 10%, what is this project’s net present value?

• If the discount rate is 18%, what is this project’s net present value?

Now draw (for yourself) a chart where the discount rate is on the horizontal axis (the “x” axis) and the net present value on the vertical axis (the Y axis). Plot the net present value of the project as a function of the discount rate by dots for the four discount rates. connect the four points using a free hand ‘smooth’ curve. The curve intersects the horizontal line at a particular discount rate. What is this discount rate at which the graph intersects the horizontal axis?

[ Observe the graph and write a short paragraph stating what the graph ‘shows]

c. A project requiring a \$4.2 million investment has a profitability index of 0.94. What is its net present value? (Remember: Profitability Index is defined as Present Value of the proceeds divided by the initial investment)

Part 2.

Read the article below. Then write a one-to-two page paper answering the following question:

Which method do you think is the better one for making capital budgeting decisions – IRR or NPV?

Internal rate of return
Computerworld. Framingham, Feb 17, 2003, Gary H Anthes.

Abstract:
Internal rate of return (IRR) is the flip side of net present value (NPV) and is based on the same principles and the same math. NPV shows the value of a stream of future cash flows discounted back to the present by some percentage that represents the minimum desired rate of return, often a company’s cost of capital. IRR, on the other hand, computes a break-even rate of return. It shows the discount rate below which an investment results in a positive NPV and above which an investment results in a negative NPV. It is the breakeven discount rate, the rate at which the value of cash outflows equals the value of cash inflows.

### Assignment Expectations

This assignment consists of a quantitative section (Part 1) and a an essay section (Part 2) below. Upload both sections as one Word document by the end of the Module.