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Capital Budgeting


Question 2 Capital Investment Decisions (16 marks) Chima construction Ltd is deciding whether to purchase certain equipment in the coming year. The capital budget has a cap of $6,800,000 for the year. Stephen, project analyst at Chima construction Ltd, is preparing an analysis of the three projects under consideration by Rod, the company’s owner. Project A Project B Project C Projected cash outflow Net initial investment $5,000,000 $1,500,000 $4,000,000 Projected cash inflows Year 1 $1,000,000 $400,000 $1,000,000 Year 2 $1,000,000 $1,000,000 $1,000,000 Year 3 $1,500,000 $1,000,000 $2,100,000 Year 4 $1,500,000 $500,000 $1,000,000 Year 5 $3,000,000 $300,000 $300,000 Required rate of return 8% 8% 8% REQUIRED a) Calculate the payback period for each of the three projects. Ignore income taxes. Using the payback method, which project should Chima construction Ltd choose? b) Stephen thinks that projects should be selected based on their NPVs. Assume all cash flows occur at the end of the year except for initial investment amounts. Calculate the NPV for each project. Provide NPV projects ranking. c) Which projects would you consider should be funded? Briefly explain the reasons for your decision.