Caledonia Project

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Caledonia Project

Caledonia Project
FIN/370
Julie Vogt
January 9, 2012

Week 4 Team project was to answer question 12 a-e on page 363, Chapter 10 of Financial Management: Principles and Applications.
12. 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. a. What is each project’s payback period? According to Financial Management: Principles and Applications Payback period is defined as “A capital-budgeting
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PVIFAi,n = 1-(1/ (1+i)n / i (equation 5-10a on p. 155)

Per Financial Management: Principles and Applications, the variables are defined as:
FCFt = the annual free cash flow in time period t (this can take on either positive or negative values)
IO = the initial cash outlay
N = the project’s expected life
IRR = the project’s internal rate of return
(Keown, Martin, Petty, & Scott, 2005, p. 299)
PVIFAI,N = Present-value interest factor for an annuity
(Keown, Martin, Petty, & Scott, 2005, p. 155)

Project A = Internal rate of return is 18%.

$100,000 = $32,000 (PVIFAi 5yrs)
$100,000 / $32,000
3.125(PVIFAi 5yrs) = 18%
Project B = Internal rate of return is 15%.

$100,000 = $200,000 (PVIFAi 5yrs)
$100,000 / $200,000
0.5(PVIFAi 5yrs) = 15% d. What has caused the ranking conflict? According to Financial Management: Principles and Applications ranking conflicts can be a result of a “size disparity problem, the time disparity problem, and unequal lives” (Keown, Martin, Petty, & Scott, 2005, p. 355).

To determine the best option all factors need to be looked at. Here is the ranking conflict:

Project A has an initial outlay of $100,000 receiving $160,000 cash flow over the next 5 years.

___ $32,000__ _$32,000__ $32,000___$32,000___$32,000
$100,000 1 2
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