### If the discount rate is 0%, what is the project’s net present value?

Posted on # If the discount rate is 0%, what is the project’s net present value?

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Capital Budgeting

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.

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Capital Budgeting Practice Problems

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

Year Cash flow

0 – \$400,000

1 \$100,000

2 \$120,000

3 \$850,000

If xxxxxx discount xxxxxx is 0%, xxxxxx is xxxxxx project’s net present value?

At 0% discount xxxxxx sum of xxxxxx expected cash flows is xxxxxx net present value

Net present value = \$400,000 + \$ 100,000 + \$120,000 + \$ 850,000

= \$ 1,470,000

If xxxxxx discount xxxxxx is 2%, xxxxxx is xxxxxx project’s net present value?

At 2% discount xxxxxx xxxxxx net present value is (\$400,000(9.98) ^3) + (\$100,000 (9.98) ^2) + (\$120,000 (9.98) ^1) + (\$850,000 (9.98) ^0)

= \$1,414,353.45

If xxxxxx discount xxxxxx is 6%, xxxxxx is xxxxxx project’s net present value?

At6% discount xxxxxx xxxxxx net present value is (\$400,000(9.94) ^3) + (\$100,000 (9.94) ^2) + (\$120,000 (9.94) ^1) + (\$850,000 (9.94) ^0)

\$1,314,815.59

If xxxxxx discount xxxxxx is 11%, xxxxxx is xxxxxx project’s net present value?

(\$400,000(9.89) ^3) + (\$100, 