Capital Budget
Cases and Exercises for Value and Capital Budgeting
Corporate Finance Academic Year 2012/2013
1. The treasurer of Amaro Canned Fruits has projected the cash flows of projects A, B and C as follows (measured in e): Year 0 Project A Project B Project C Year 1 70, 000 130, 000 75, 000 Year 2 70, 000 130, 000 60, 000
−100, 000 −200, 000 −100, 000
Suppose the relevant discount rate is 12% per annum. (a) Compute the profitability index for each of the three projects. (b) Compute the NPV for each of the three projects. (c) Suppose these three projects are independent. Which project(s) should Amaro accept, based on the profitability index rule? (d) Suppose these three projects are mutually exclusive. Which project(s) should Amaro accept, based on the profitability index rule? (e) Suppose Amaro’s budget for these projects is e 300,000. The projects are not divisible. Which project(s) should Amaro accept? (f) What would be Amaro’s choice, based on the IRR rule? 2. You are a senior manager at Airbus and have been authorised to spend up to e 200,000 for projects. The three projects you are considering have the following characteristics: Project A Initial investment of e 150,000. Cash flow of e 50,000 at year 1 and e 100,000 at year 2. This is a plant expansion project, where the required rate of return is 10%. Project B Initial investment of e 200,000. Cash flow of e 200,000 at year 1 and e 111,000 at year 2. This is a new product development project, where the required rate of return is 20%. Project C Initial investment of e 100,000. Cash flow of e 100,000 at year 1 and e 100,000 at year 2. This is a market expansion project, where the required rate of return is 20%. Assume the corporate discount rate is 10%. Please offer your recommendations, based on (a) (b) (c) (d) the payback period method; the IRR method; the profitability index method; and the NPV method.
3. Case Study: Randgold Resources plc Randgold resources plc is a London Stock Exchange gold mining and discovery
Corporate Finance Academic Year 2012/2013
1. The treasurer of Amaro Canned Fruits has projected the cash flows of projects A, B and C as follows (measured in e): Year 0 Project A Project B Project C Year 1 70, 000 130, 000 75, 000 Year 2 70, 000 130, 000 60, 000
−100, 000 −200, 000 −100, 000
Suppose the relevant discount rate is 12% per annum. (a) Compute the profitability index for each of the three projects. (b) Compute the NPV for each of the three projects. (c) Suppose these three projects are independent. Which project(s) should Amaro accept, based on the profitability index rule? (d) Suppose these three projects are mutually exclusive. Which project(s) should Amaro accept, based on the profitability index rule? (e) Suppose Amaro’s budget for these projects is e 300,000. The projects are not divisible. Which project(s) should Amaro accept? (f) What would be Amaro’s choice, based on the IRR rule? 2. You are a senior manager at Airbus and have been authorised to spend up to e 200,000 for projects. The three projects you are considering have the following characteristics: Project A Initial investment of e 150,000. Cash flow of e 50,000 at year 1 and e 100,000 at year 2. This is a plant expansion project, where the required rate of return is 10%. Project B Initial investment of e 200,000. Cash flow of e 200,000 at year 1 and e 111,000 at year 2. This is a new product development project, where the required rate of return is 20%. Project C Initial investment of e 100,000. Cash flow of e 100,000 at year 1 and e 100,000 at year 2. This is a market expansion project, where the required rate of return is 20%. Assume the corporate discount rate is 10%. Please offer your recommendations, based on (a) (b) (c) (d) the payback period method; the IRR method; the profitability index method; and the NPV method.
3. Case Study: Randgold Resources plc Randgold resources plc is a London Stock Exchange gold mining and discovery