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Caledonia -Integrative Problem

Business, Finance - Year 3
Finance Questions
      “Caladonia Products” Integrative Problem

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                     0
2 32,000                     0
3 32,000                     0
4 32,000                     0
5 32,000                 $200,000

The required rate of return on these projects is 11 percent

Formulate answers and show all work

A. What is each project’s payback period?
B. What is each project’s net present value?
C. What is each project’s internal rate of return?
D. What has caused the ranking conflict?
E. Which project should be accepted? Why?

F. Describe the factors that Caladonia would have to consider if they were doing a lease versus buy for the two projects.

Project A

Payback period is defined as the expected number of years required to recover the original investment.

Period 0 1 2 3 4 5
Net cash flow -100,000 32,000 32,000 32,000 32,000 32,000
Cumulative NCF -100,000 -68,000 -36,000 -4,000 28,000 60,000

Payback = Year before full recovery + Unrecovered cost at start of year
Cash flow during year

= 3 + 4,000/32,000 = 3.125 years

Net Present Value

Required rate of return = 11.00%

First, we need to find the present value for the total projected cash flow by using the above required rate of return.
Cash flow from operations 32,000 32,000 32,000 32,000 32,000
Present value of projected cash inflow -฿28,828.83 -฿25,971.92 -฿23,398.12 -฿21,079.39 -฿18,990.44

Total present value of projected cash inflow = -฿118,268.70

NPV = Initial investment + present value of projected cash inflow
NPV = -100,000 + 118,268.70
NPV = 18,269

Internal Rate of Return

The internal rate of return is defined as that discount rate which equates the present value of a project's...