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NAME: ______________________________________

CAPITAL BUDGETING ACTIVITY


1. Texabonds Inc has decided to consider a project where they predict the annual cash flows to be $5,000,
$3,000 and $4,000, respectively for the next three years. At the beginning of the project, the
initial investment put into the project is $10,000. Use the Profitability Index Method and a discount rate of 12%
to determine if this is a good project to undertake.?

2. Company ABC Ltd which has decided to invest in a project where they estimate the following annual cash
flows:
• $5,000 in Year 1
• $3,000 in Year 2
• $4,000 in Year 3

At the beginning of the project, the initial investment required for the project is $10,000 and the discounting
rate is 10%. Use Profitability Index to determine if the project worth investing?

3. Let's say you have two machines in your warehouse. Machine A costs $20,000 and your firm expects payback
at the rate of $5,000 per year. Machine B costs $12,000 and the firm expects payback at the same rate as
Machine A. Calculate the two scenarios using payback period and which machine should be chosen?

4. The Delta company is planning to purchase a machine known as machine X. Machine X would cost $25,000
and would have a useful life of 10 years with zero salvage value. The expected annual cash inflow of the
machine is $10,000. Compute payback period of machine X and conclude whether or not the machine would
be purchased if the maximum desired payback period of Delta company is 3 years.
5. An initial investment of $8,320 thousand on plant and machinery is expected to generate net cash flows of
$3,411 thousand, $4,070 thousand, $5,824 thousand and $2,065 thousand at the end of first, second, third
and fourth year respectively. At the end of the fourth year, the machinery will be sold for $900 thousand.
Calculate the net present value of the investment if the discount rate is 18%.?

6. Company “Tianpogi” who is determining whether they should invest in a new project. Tianpogi will expect to
invest $500,000 for the development of their new product. The company estimates that the first year cash flow
will be $200,000, the second year cash flow will be $300,000, and the third year cash flow to be $200,000.
The expected return of 10% is used as the discount rate.

The following table provides each year's cash flow and looking for the present value of each cash flow.
Determine the NPV? (Show solution)

Year Cash Flow Present Value


0 -$500,000 -$500,000
1 $200,000 $_________
2 $300,000 $_________
3 $200,000 $_________ Net Present Value = _________________?

7. Tom’s Machine Shop is considering purchasing a new machine, but he is unsure if it’s the best use of company
funds at this point in time. With the new $100,000 machine, Tom will be able to take on a new order that will
pay $20,000, $30,000, $40,000, and $40,000 profit at the end of first, second, third and fourth year
respectively.

Calculate Tom’s minimum rate (IRR). Since it’s difficult to isolate the discount rate unless you use an excel
IRR calculator. You can start with an approximate rate and adjust from there. Let’s start with 7 percent and to
be followed by 8% up to 12%..