business discussion question and need guidance to help me learn.
please check the attachments my answers are in red. i need you to check my answers and complete 2 questions. ( question 4 from part 1 and question 2 from part 2)
Requirements: as needed
The Investment Detective
The essence of capital budgeting and resource allocation is a search for good investments in which to invest the firm’s capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital budgeting analyst is necessarily, therefore, a detective who must winnow good evidence from bad. Much of the challenges is knowing what quantitative analysis to generate in the first place.
Suppose that you are a new capital budgeting analyst for a company considering investments in the eight projects listed in Exhibit 1. The chief financial officer of your company has asked you to rank the projects and recommend the “four best” that the company should accept.
Part I (50%)
For the first part of this assignment, only quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive.
All projects require the same initial investment, $2,000,000. Moreover, all are believed to be of the same risk class. The weighted average cost of capital for the first part is 10%. To simulate your analysis, consider the following questions:
Can you rank the projects simply by inspecting the cash flows shown in Exhibit I? (5%)
We cannot rank the projects simply by inspecting the cash flows in Exhibit 1 as the time value of money was not considered. In order to be able to rank the project we need to bring the cash flow to the present before we can start ranking.
What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why? (15%)
There are several criteria that can be used such as Net present value(NPV), internal rate of return (IRR), Payback Period, Profitability Index(PI) , and a couple more. Among these methods, NPV is the best method to use as it is probably the most reliable and comprehensive. It take into consideration the time value of money and all cash flows throughout the life of the project. IRR only portrays a percentage and ignores the magnitude of the cash flows. The payback period ignores the time value of money. Payback period and profitability index provide a quick assessment of a project’s viability but they have their limitations such as not considering the full range of cash flows. Due to these reasons NPV is the most preferred and best method.
What is the ranking you found by using quantitative methods (please show all your calculations)? (20%) Does this ranking differ from the ranking obtained by a simple inspection of the cash flows? (5%)
Ranks obtained by a simple inspection of the cash flows.
Ranks obtained by a NPV AND IRR (check excel sheet)
The ranking differs from the ranking we get by a simple inspection of the cash flow.
What kinds of real investment projects have cash flows similar to those in the exhibit? (5%)
Part II (50%)
The company has the following capital structure:
Calculate the weighted average cost of capital (WACC) with a tax rate of 36%. (20%)
WACC = 12.96% (check excel or formula below)
Weighted average cost of capital = (2,000,000/5,000,000) x(10% x (1-.36) ) (.500,000/5,000,000) x 14% + (2,500,000/5000000) x 18%
Using the same cash flows in exhibit I find the NPV, PI, IRR and MIRR (Use the WACC you have computed above). Which project(s) would you recommend and why (show your calculations)? (30%)
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