7. A public decision-maker has a budget of $100 which must be spent in the current year. Three projects are proposed, each of which is indivisible (it is not possible to undertake less than the whole project) and non- reproducible (it is not possible to construct two versions of the same project). The discount rate is 10% per annum. The project benefits and costs are summarized in the following Table: Project Cost (s) Benefits ($) Year 2 Year o Year 1 A 30 40 0 B 30 0 50 с 70 0 100 (i) Work out the Net Present Value (NPV), Internal Rate of Return (IRR) and Benefit/Cost Ratio (B/C) for each project; (ii) Rank the projects according to the NPV, IRR and B/C investment criteria; (iii) Which projects should be undertaken to spend the budget: (a) if the reinvestment rate is 22% per annum; (b) if the reinvestment rate is 28% per annum?
7. A public decision-maker has a budget of $100 which must be spent in the current year. Three projects are proposed, each of which is indivisible (it is not possible to undertake less than the whole project) and non- reproducible (it is not possible to construct two versions of the same project). The discount rate is 10% per annum. The project benefits and costs are summarized in the following Table: Project Cost (s) Benefits ($) Year 2 Year o Year 1 A 30 40 0 B 30 0 50 с 70 0 100 (i) Work out the Net Present Value (NPV), Internal Rate of Return (IRR) and Benefit/Cost Ratio (B/C) for each project; (ii) Rank the projects according to the NPV, IRR and B/C investment criteria; (iii) Which projects should be undertaken to spend the budget: (a) if the reinvestment rate is 22% per annum; (b) if the reinvestment rate is 28% per annum?
Chapter9: Capital Budgeting And Cash Flow Analysis
Section: Chapter Questions
Problem 3P
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Transcribed Image Text:7.
A public decision-maker has a budget of $100 which must be spent in the
current year. Three projects are proposed, each of which is indivisible (it is
not possible to undertake less than the whole project) and non-
reproducible (it is not possible to construct two versions of the same
project). The discount rate is 10% per annum. The project benefits and
costs are summarized in the following Table:
Project Cost (s)
Year o
Benefits ($)
Year 2
Year 1
A
30
40
0
B
30
0
50
с
70
0
100
(i)
Work out the Net Present Value (NPV), Internal Rate of Return
(IRR) and Benefit/Cost Ratio (B/C) for each project;
(ii)
Rank the projects according to the NPV, IRR and B/C investment
criteria;
(iii)
Which projects should be undertaken to spend the budget:
(a)
if the reinvestment rate is 22% per annum;
(b)
if the reinvestment rate is 28% per annum?
Answer:
(In answering this question the student should assume that the full amount of
the budget must be exhausted on some combination of the three projects; ie. it
cannot be assumed that some part of the initial budget is invested at the
reinvestment rate. It should also be assumed that end of year 2 is the terminal
year.)
(i)
NPV
IRR
BCR
A
$6.36
33%
1.21
B
$11.32
29%
1.38
C
$12.64
20%
1.18
(ii) rank by: NPV C, B, A
IRR
A, B, C
BCR
B,A,C
(iii) Only project A is affected by the reinvestment rate.
(a) At 22% the future value of $40 at end of year 2 is $48.8. Therefore
select projects B and C to maximize return on $100 investment.
(b) At 28% the future value of $40 at end of year 2 is $51.2. Therefore
select projects A and C to maximize return on $100 investment.
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