Capital Budgeting Case Study
February 23, 2014
The purpose of this paper is to analyze and interpret the answers of the Capital Budgeting Case. I will discuss my recommendation about which Corporation and investor should acquire based on the quantitative reasoning. I also will describe the relationship between the net present value and the internal rate of return for the two corporations that are analyzed.
Capital Budgeting Case
A company is planning in acquiring a new corporation and there are two options with the same cost of $250,000 but both with different 5-year projections of cash flows. The evaluation done to the two corporations (A and B) is based on the Net Present Value (NPV) and the Internal Rate of Return (IRR).
The net present value represents the value the project or investment adds to the investor wealth. The NPV method of capital budgeting suggests that all projects that have positive NPV should be accepted because they would add value to the investment. On the other hand, the internal rate of return is defined as the discount rate that equates the present value of a project's cash inflows to its outflows. According to the internal rate of return method of capital budgeting, the investment should be accepted if their IRR is greater than the cost of capital.
The results for Corporation “A” shows a NPV of $20,979.20 based on discount rate of 10%. And, we got an IRR of 13.05% which means that is the discount rate that makes the NPV equal or close to $0.00. On the other hand, the Corporation “B” with a discount rate of 11% got a NPV of $40,251.47 and an IRR of 16.94%. A positive NPV is considered a good project, and we want to choose the one with the highest NPV.
Therefore, I would recommend acquiring the Company “B” because it has a higher NPV than the other company. Corporation B will be giving us a current value cash return of $40,251.47 above our 11% required rate of return during the next 5...
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