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Initial outlay Inflow year 1 Inflow year 2 Inflow year 3 Inflow year 4 Inflow year 5 Inflow year 6 PROJECT x $400,000 $80,000 $140,000 $130,000
You are a Financial Analyst with Challenger Ltd and the chief financial officer (CFO) requests you to evaluate two new capital budgeting proposals. Specifically, you are asked to provide a recommendation and also respond to a number of questions aimed at assessing your level of competence in capital budgeting process.
Instructions are as follows: Provide an evaluation of two proposed projects, both with identical initial outlays of $400,000. Both of these projects involve additions to a client's highly successful product line. The required rate of return on both projects is set at 11%. The expected after-tax cash flows from each project are as presented in the table below.
In evaluating these projects, please respond to the following questions:
3. Distinguish between "required rate of return" and "internal rate of return". Illustrate your answer with examples.
4. What is the payback period on each project? If Challenger Ltd imposes a 2.5-year maximum acceptable payback period, which of these projects should be accepted?
5. What are the main limitations of the pay back method of valuation. Despite these limitations, chief financial officers (CFOs) use it. Explain why.
6. Determine the NPV for each of these projects? Should the projects be accepted? Explain.
7. Determine the IRR for each of these projects? Should the projects be accepted? Explain.
8. Under what circumstances will the NPV and IRR offer different recommendations, and which recommendation is preferred? Carefully explain
9. How would you accommodate unequal lives of the project while determining the NPVs of the project? Demonstrate using calculations.
10. Explain why unequal lives of projects make NPVs of the projects incomparable.
11. Determine the profitability index for each of these projects? Should the projects be accepted? Explain. (5 marks)
Initial outlayInflow year 1Inflow year 2Inflow year 3Inflow year 4 Inflow year 5 Inflow year 6 PROJECT x$400,000$80,000$140,000$130,000 $160,000 PROJECT Y$400,000$160,000$160,000$160,000$160,000$160,000 $ 160,000