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Determine the PI for each of these projects. Should they be accepted?Would you expect the NPV and PI methods to give consistent accept/reject decisions? Why or why not?

01 / 10 / 2021 Assignment

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Your first assignment
in your new position as assistant financial analyst at Caledonia Products is to
evaluate two new capital-budgeting proposals. Because this is your first
assignment, you have been asked not only to provide a recommendation but also
to respond to a number of questions aimed at assessing your understanding of
the capital-budgeting process. This is a standard procedure for all new
financial analysts at Caledonia, and it will serve to determine whether you are
moved directly into the capital-budgeting analysis department or are provided
with remedial training. The memorandum you received outlining your assignment
follows:

To: The New Financial
Analysts

From: Mr. V. Morrison,
CEO, Caledonia Products

Re: Capital-Budgeting
Analysis

Provide an evaluation
of two proposed projects, both with 5-year expected lives and identical initial
outlays of $165,000. Both of these projects involve additions to Caledonia’s
highly successful Avalon product line, and as a result, the required rate of return
on both projects has been established at 12 percent. The expected free cash
flows from each project are as follows:


PROJECT A

PROJECT
B

Initial
outlay

?$165,000

?$165,000

Inflow
year 1

30,000

60,000

Inflow
year 2

45,000

60,000

Inflow
year 3

60,000

60,000

Inflow year 4

75,000

60,000

Inflow
year 5

105,000

60,000

In evaluating these
projects, please respond to the following questions. For questions from (a) to
(j) assume that the projects are independent. That is both could be accepted if
both are acceptable.

a. What is the payback
period on each project? If Caledonia imposes a 3-year maximum acceptable
payback period, which of these projects should be accepted?

b. What are the
criticisms of the payback period?

c.Determine the NPV for
each of these projects. Should they be accepted?

d. Describe the logic
behind the NPV.

e.Determine the PI for
each of these projects. Should they be accepted?

f.Would you expect the
NPV and PI methods to give consistent accept/reject decisions? Why or why not?

FIN325/ Corporate
Finance, Assignment #2

g. Determine the IRR for
each project. Should they be accepted?

h. What reinvestment rate
assumptions are implicitly made by the NPV and IRR methods? Which one is
better?

i. Determine the MIRR for
each project. Should they be accepted?

j. Describe the logic
behind the MIRR.

k. Rank the two project
based on all above criteria and make a recommendation as to which (if either)
should be accepted under the assumption that the projects are mutually
exclusive.

l.
Caledonia
is considering two additional mutually exclusive projects. The free cash flows
associated with these projects are as follows:


PROJECT A

PROJECT B

Initial
outlay

-$150,000

-$150,000

Inflow year 1

48,000

0

Inflow
year 2

48,000

0

Inflow year 3

48,000

0

Inflow
year 4

48,000

0

Inflow
year 5

48,000

300,000

The required rate of return on
these projects is 11 percent.

1. What is each project’s
payback period?

2. What is each project’s
NPV?

3. What is each project’s
IRR?

4. What has caused the
ranking conflict?

5. Which project should
be accepted? Why?



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