finance assignment

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Assignment #4

The purpose of this assignment is to solidify your understanding on the capital budgeting

techniques (mainly Net Present Value and Internal Rate of Return). The scores of this

assignment will help in assessing the following learning goal of the course: “students

successfully completing this course will be able to apply capital budgeting techniques to evaluate

long term investment decisions of firm.

Instructions:

You are required to use a financial calculator or spreadsheet (Excel) to solve problems (provided

on page 4) on capital budgeting. You are required to complete the following 5 steps (sample

questions and solutions are provided for guidance):

(i) Develop the timeline (linear representation of the timing of cash flows)

(ii) Calculate the Internal Rate of Return (IRR)

(iii) Calculate the Net Present Value (NPV) at the following required rates of return:

(a) 3% (b) 4% (c) 8% (d) 9%

(iv) Using IRR and NPV criterion, comment if the project should be accepted or rejected

at the following required rates of return:

(a) 3% (b) 4% (c) 8% (d) 9%

(v) Plot the Net Present Value profile (NPV on Y axis and rates of return on X-axis).

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Sample Question and Solution Question:

Your firm is considering an investment that will cost $1.5 million today today. The project will produce cash flows of $350,000 in year 1, $390,000 in years 2 through 4, and $450,000 in year 5.

(i) Develop the timeline (linear representation of the timing of cash flows)

(ii) Calculate the Internal Rate of Return (IRR)

(iii) Calculate the Net Present Value (NPV) at the following required rates of return:

(a) 7% (b) 8% (c) 10% (d) 12%

(iv) Using IRR and NPV criterion, comment if the project should be accepted or rejected at

the following required rates of return:

(a) 7% (b) 8% (c) 10% (d) 12%

(v) Plot the Net Present Value profile (NPV on Y axis and rates of return on X-axis).

Solution:

(i) Timeline

Years 0 1 2 3 4 5 Cash Flows -1,500,000 350,000 390,000 390,000 390,000 450,000

(ii) IRR: 9.48%

(iii) (a) NPV at 7% : $104,473 (a) NPV at 8%: $60,955 (b) NPV at 10%: ($20,702) (c) NPV at 12%: ($95,806)

(iv) (a) At required rate of return of 7%, accept the project since IRR > 7% and NPV > 0 (b) At required rate of return of 8%, accept the project since IRR > 8% and NPV > 0 (c) At required rate of return of 10%, reject the project since IRR <10% and NPV <0 (d) At required rate of return of 12%, reject the project since IRR <12% and NPV <0

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(v) NPV Profile:

-150,000

-100,000

-50,000

0

50,000

100,000

150,000

0% 2% 4% 6% 8% 10% 12% 14%

N et P re se nt V al ue

s ( $)

Required Rates of Return

NPV Profile

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Assignment Problems

Kingston Corp. is considering a new machine that requires an initial investment of $550,000

installed, and has a useful life of 8 years. The expected annual after-tax cash flows for the

machine are $89,000 during the first 3 years, $95,000 during years 4 through 6 and $105,000

during the last two years.

(i) Develop the timeline (linear representation of the timing of cash flows)

(ii) Calculate the Internal Rate of Return (IRR)

(iii) Calculate the Net Present Value (NPV) at the following required rates of return:

(b) 3% (b) 4% (c) 8% (d) 9%

(iv) Using IRR and NPV criterion, comment if the project should be accepted or rejected

at the following required rates of return:

(b) 3% (b) 4% (c) 8% (d) 9%

(v) Plot the Net Present Value profile (NPV on Y axis and rates of return on X-axis).

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Grading Rubric

Learning Objective Subcomponent Not Submitted

0

Does Not Meet Expectations

1

Meets expectations

2

Exceeds Expectations

3 LO#3: The student will be able to apply capital budgeting techniques to evaluate long term investment decisions of firm.

The student will convert relevant information into various mathematical forms (e.g., equations, graphs, diagrams, tables, words)

No attempt made

Completes conversion of information but resulting mathematical portrayal is inappropriate or inaccurate

Completes conversion of information into mathematical portrayal

Relevant information is expressed in an insightful mathematical portrayal in a way that contributes to a further or deeper understanding (e.g., correctly develops timeline of cash flows by labeling initial investments, future cash flows and required rate of return)

The student will calculate NPV and IRR using a timeline of cash flows

No attempt made

Calculations are attempted but are both unsuccessful and not comprehensive

Calculations are attempted to solve the problem but not comprehensive

Calculations attempted are essentially all successful and sufficiently comprehensive to solve the problem. Calculations are also presented elegantly (e.g., correctly identifies the values of the initial investments and future cash flows with inflows and outflows and computes the NPV and IRR)

The student will draw conclusion on acceptance or rejection of an investment project based on capital budgeting criterion

No attempt made

Draws incorrect conclusion on the acceptance or rejection of an investment project and incorrectly interprets the capital budgeting criterion

Draws correct conclusion on the acceptance or rejection of an investment project but partially interprets the capital budgeting criterion

Draws correct conclusion on the acceptance or rejection of an investment project by correctly and comprehensively interpreting the capital budgeting criterion (e.g., correctly draws conclusion by interpreting the NPV profile and indicating capital budgeting rules: NPV>0, NPV<0, IRR>COC, IRR<COC)