Question

The Dilemma at eUREKA.com Comparison of Capital Budgeting Techniques eUREKA.com is trying to decide between two alterntive machines. They are aware that they have several methods to evaluate and compare the alternatives. They give the task of evaluating the two alternatives using different techniques to Tolga and Aisha. They work a day and invite the department for a meeting the next morning. That morning all department members gather together to go over the problems from beginning to the end. Tolga and Aisha go aver their calculations step by step trying to explain to the members of the department the caveats of the methods and how they should be used if chosen as the decision making criteria. Thye put the slide with the following cash flows to the screen and ask for everyone to take a very careful look at the numbers. Year Simtotech Valarium 350000 600000 650000 1. Calculate the Payback Period of each project. should make to show that the Payback Period is not appropriate in this case. Calculate the Discounted Payback Period (DPP) using 10% as the discount rate. Should Tolga and Aisha ask the Department Head to use DPP as the deciding factor? Explain. Calculate the two projects' IRR. How should Tolga and Aisha convince the Department Head that the IRR measure could be misleading? Construct the NPV profile graphic for the two projects and explain the relevance of the crossover point. How should Tolga and Aisha convince the Board that the NPV method is the way to go? Explain what argument Tolga and Aisha 2. 4. S. Explain how Tolga and Aisha can show that the Modified Internal Rate of Return is the more realistic measure to use in the case of mutually exclusive projects. You may use 10% as the reinvestment rate.
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Answer 1

1: Payback of S is 2.5 years while that of V is 1.5 years. Since the initial investment varies a lot, this is mot a suitable measure.

2: Discounted payback of S= 2.94

V= 3.92

Again due to changes in the initial investment this is not the conclusive method. This is better than the payback method since it takes into account the timing of cash flows.

3: IRR of S= 36.63%, V= 42.91%

This means that the returns of V vary. However due to scale of the project being different this cannot be the deciding factor.

4:

Disount rate	NPV S	NPV V
20%	453575.10	328215.02
29%	175279.12	173445.08
29%	172671.75	171948.06
29.17%	170852.05	170902.71
29.50%	162333.66	166002.76
30%	149613.65	158666.07
31%	124829.84	144301.22
32%	100888.78	130334.40
33%	77753.59	116750.25
40%	-64348.19	31231.03
50%	-220164.61	-67489.71

Crossover rate is that at which the NPV of two projects is equal. NPV is the better method since it takes into account the time value of money and the project which yields the most value is selected.

WORKINGS

Year	S	Cumulative cash flow	Discounted CF	Cumulative discounted CF	V	Cumulative cash flow	Discounted CF	Cumulative discounted CF
0	-1000000	-1000000	-1000000	-1000000	-800000	-800000	-800000	-800000
1	350000	-650000	318181.8182	-681818.1818	600000	-200000	-181818.1818	-981818.1818
2	400000	-250000	330578.5124	-351239.6694	400000	200000	165289.2562	-816528.9256
3	500000	250000	375657.4005	24417.73103	300000	500000	375657.4005	-440871.5252
4	650000	900000	443958.746	468376.477	200000	700000	478109.4188	37237.89359
5	700000	1600000	434644.9261	903021.4032	200000	900000	558829.1908	596067.0843
Payback		2.5				1.5
Discounted payback		2.935				3.922114286
IRR		36.63%				42.91%