Intrek, Inc. is evaluating three capital budgeting projects with code names A. B and C. Investment in all three projects is supposed to take place immediately (t = 0). The inflation rate is assumed to be equal to zero over the lives of the three projects. The three projects are of identical risk and the company believes 11% is the appropriate discount rate. The effective tax rate for the company is 40%. Project A has an immediate cost of $200,000 in addition to its installation cost of $12,500. This project will provide the company with pre-tax cost savings of $60,000 at the end of each of the next eight years. Project A falls in the 5-year MACRS class and has a zero salvage value at the end of its eighth year.

Project B requires an initial investment of $120,000 and its only net cash inflow of $150,000 occurs at the end of the first year of its life. Project C requires an initial investment of $30,000. The project provides a net cash flow of $150,000 at the end of the first year and calls for a net cash outflow of $120,000 at the end of the second year of its life. You are expected to rank the three projects for Infra. Use several quantitative capital budgeting criteria to rank these projects and report your rankings. Most likely you will get different rankings for the different criteria. Nevertheless, your boss expects you to recommend only one ranking; the best ranking.

First, provide your best ranking assuming projects A, B, and C arc independent of each other. Second, provide your best ranking assuming that projects A and B are mutually exclusive and both independent of project C. Furthermore, if projects A and B are mutually exclusive your boss wants you to determine for what discount rates project A will be chosen over B and for what discount rates project B will be preferred over A. Regardless of whether projects A and B are independent of each other or mutually exclusive, it is very important that you justify in detail your best ranking. Intrek is also considering a fourth project with code name I).

Project 13 requires an initial investment of $40,000. However, the company may choose between two alternatives regarding the net cash flows from project D. Under the first alternative, the project is expected to provide annual cash flows of 56,000 at the end of each of the next ten years. Under the second alternative, the company may reinvest 15% of the annual cash flows in the project resulting in a 5% increase in the future cash flows each year for ever. To clarify, the project's cash flow at the end oldie first year Is expected to be $6,000 (the same as in the first alternative). Now however, the company will keep only $5,100 and will reinvest the remaining $900 in the project; this will result in a $6,300 cash flow at the end of the second year. The company will repeat this process year after year in perpetuity. If the appropriate discount rate for project D is 13%, which of the two net cash flow alternatives would you recommend to Intrek?

Answer rating: 100% (QA)

The selection of projects would be based on their respective IRRs NPVs and if they are independent or mutually exclusive of each other or not The same ... View the full answer