You are a financial analyst for Hittle Company. The director of capital budgeting has asked you to analyze two proposed capital investments, Projects X and Y. Each project has a cost of $10,000, and the cost of capital for each project is 10 percent. The payback cutoff period is 3 years. The projects’ expected net cash flows are as follows:
Expected Net Cash Flows
Year
Project X
0 ($10,000)
1 6,500
2 3,000
3 3,000
4 1,000
Project Y
($10,000) 3,500 3,500 3,500 3,500
a) Calculate each project’s payback period, net present value (NPV), profitability index (PI), and internal rate of return (IRR).
b) Which project or projects should be accepted if they are independent? Why?
c) Which project should be accepted if they are mutually exclusive? Why?
d) How does your answer to c) change if the cost of capital is 5 percent? Is there a conflict between the NPV and IRR rankings of these two projects?
e) Over what range of discount rates would you choose project X? Project Y? (Hint: Calculate the crossover rate or plot the NPV profiles.)
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