FIN 370 Finance For Business Week 4 Learning Team Assignment Caladonia Products Integrative Proble

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Problem 12, Chapter 10
Team
Members
FIN 370/Finance for Business/
University of Phoenix
July 14, 2011
Instructor

12. Caledonia is considering two additional mutually exclusive projects. The cash flows associated with these projects are as follows: Year
 
Project A
 
Project B
0
 
($100,000)
 
($100,000)
1
 
32,000
 
 
2
 
32,000
 
 
3
 
32,000
 
 
4
 
32,000
 
 
5
 
32,000
 
$200,000

The required rate of return on these projects is 11 percent. a. What is each project’s payback period? (LaToya)
Project A: 
Project B: 

b. What is each project’s net present value? (Deneen)
Year
Project A
Project B
0
($100,000)
($100,000)
1
32,000
 
2
32,000
 
3
32,000
 
4
32,000
 
5
32,000
$200,000

NPV
$16,458.29
$72,234.40

Excel Formula = NPV(11%,B2:B7)
B2:B7 for project A, which entails year zero through year 5, and C2:C7 for Project B, respectively.

c. What is each project’s internal rate of return? (John)
5 Project A: 100,000 = 32,000 x ∑ 1
t=1 (1+IRR) 5

IRR = 18.03% or 18%

Project B : 100,000 = 200,000
(1+IRR) 5

IRR = 14.87% or 15%

d. What has caused the ranking conflict? (Kate)
Time disparity has caused the ranking conflict between these two projects because of the “differing reinvestment assumptions made by the net present value and the internal rate of return decision criteria”(Keown, et. al., 2005). The decision criteria for these projects are 18% and 15% with a NPV of $16,458.29 for A and $$72,234.40 for B. Even though project B appears to be a better return on investment, it really isn’t. Project A will give the company an immediate return of $32,000 and for an additional four years. This will allow Caledonia to reinvest this money immediately.

Project B, on the other hand, will leave the company waiting to receive any return on their investment. This project will leave Caledonia tied up for five years, with no cash flows to reinvest. This will inhibit the company’s ability to maximize stockholders’ wealth. e. Which project should be accepted? Why? (Charles)

Choosing between projects can depend on an investor’s perspective, we chose to take Project A as opposed to Project B because for starters it has a higher IRR of 18% as opposed to 15% for Project B. Evaluation of the NPV of the two projects shows that Project B has a NPV that is larger than Project A and therefore would increase shareholder wealth more, but under further evaluation we saw that Project A received funds at a faster rate, money that can be reinvested to earn more money, while Project B receives its funds at a later date. In the end as stated earlier we chose Project A and gave up the extra 3% rate of return for the access to funds in earlier periods. NPV for Project A= 32,000*3.696= 118,272 -100,000 for a net present value of 18,272. NPV for Project B= 200,000*.593= 118,600-200,000 for a net present value of 81,400.

Describe factors Caledonia must consider if they were doing a lease versus buy.(Kate)
The factors Caledonia would have to consider if they were wanting to lease or buy would be initial payments, payments/costs during the lease, tax benefits, if any, equipment leasing/buying, and other legal obligations. The advantages of leasing are there may not be a down payment for building or equipment rental; rather the payments would be periodic, meaning no restrictions on the company’s financial operations. Payments could be spread out over a longer period of time than if they received a loan, any leased equipment or buildings would not depreciate, and the lease payments are tax deductible (para. 14).

The disadvantages of leasing would be the lease costs more because the company does not claim ownership to any borrowed...