Case Study on Capital Budgeting

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Hittle Company Ltd (Case Study)

You are a financial analyst for the Hittle Company. The director of capital budgeting has asked you to analyze two proposed capital investments, project X and Y. Each project has a cost of $10000 and the cost of capital for each project is 12 percent. The projects expected net cash flows are as follows:

|Expected Cash flows | |  | |  | |year |Project X |Project Y | |0 |($10,000) |($10,000) | |1 |6500 |3500 | |2 |3000 |3500 | |3 |3000 |3500 | |4 |1000 |3500 | |  |  |  |

a. Calculate each projects payback period, Discounted payback period, net present value (NPV), internal rate of return(IRR) and Profitability Index

b. Which project or projects should be accepted if they are independent?

c. Which project or projects should be accepted if they are mutually exclusive?

d. How might a change in the cost of capital produce a conflict between the NPV and IRR ranking of these two projects? Would this conflict exist if k were 5%?

e. Why does the conflict exist?

(a) Calculate each projects payback period, net present value (NPV), internal rate of return (IRR) and Profitability Index

➢ Payback Period:

| | (Project X) | | (Project Y) | | | | | | | | |year |Cash flow |C.Cash Flow |year |Cash flow |C.Cash flow | |0 |($10,000) |($10,000) |0 |($10,000) |($10,000) | |1 |6500 |-3500 |1 |3500 |-6500 | |2 |3500 |-500 |2 |3500 |-3000 | |3 |3500 |2500 |3 |3500 |500 | |4 |1000 |3500 |4 |3500 |4000 | | | | | | | |

Payback X =2+$500/$3000= 2.17 years

Payback y = 2+$3000/3500= 2.86 years

➢ Discounted Payback Period :

Project X

| |  | |year |cash flows |1 / ( 1 + 0.12 ) ^ n |P.V | |0 |($10,000) |1 |  | |1 |6500 |0.892 |5798 | |2 |3000 |0.797 |2391 | |3 |3000 |0.711 |2133 | |4 |1000 |0.635 |635 | |PV of all cash flows...
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