Basics of Capital Budgeting
1 You are a financial analyst for Damon Electronics Company. The director of capital budgeting has
asked you to analyze two proposed capital investments, Projects X and Y. Each project has a cost
of $10,000, and the required rate of return for each project is 12 perce...
basics of capital budgeting 1 you are a financial analyst for damon electronics company the director of capital budgeting has asked you to analyze two propos
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Basics of Capital Budgeting
1 You are a financial analyst for Damon Electronics Company. The director of capital budgeting has
asked you to analyze two proposed capital investments, Projects X and Y. Each project has a cost
of $10,000, and the required rate of return for each project is 12 percent. The projects’ expected
net cash flows are as follows:
Expected Net Cash Flows
Year Project X Project Y
0 $(10,000) $(10,000)
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500
a. Calculate each project’s traditional payback period (PB), net present value (NPV), internal rate
of return (IRR), modified internal rate of return (MIRR), and discounted payback period
(DPB).
b.Which project or projects should be accepted if they are independent?
c. Which project should be accepted if they are mutually exclusive?
d.How might a change in the required rate of return produce a conflict between the NPV and IRR
rankings of these two projects? Would this conflict exist if r were 5 percent? (Hint: Plot the
NPV profiles.)
e. Why does the conflict exist?
, a. Payback:
To determine the payback, construct the cumulative cash flows for each project:
Project X Project Y
Year Cash Flows Cumulative CF Cash Flows Cumulative CF
0 ($10,000) ($10,000) ($10,000) ($10,000)
1 6,500 (3,500) 3,500 (6,500)
2 3,000 (500) 3,500 (3,000)
3 3,000 2,500 3,500 500
4 1,000 3,500 3,500 4,000
$500
Payback X 2 2.17 years
$3,000
$3,000
Payback Y 2 2.86 years
$3,500
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