QUESTION 1:

a) Your first assignment in your new position as assistant financial analyst at Goggle Inc. 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 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: Ms. Azizah, CEO, Goggle Inc.

Re: Capital-Budgeting Analysis

Provide an evaluation of two proposed projects, both with 5-year expected lives and identical initial outlays of $110,000. Both of these projects involve additions to Goggle’s highly successful apparel 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:

In evaluating these projects, please respond to the following questions:

i. Why is the capital-budgeting process so important?

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

iii. What are the two criticisms of the payback period?

iv. Determine the NPV for each of these projects. Should either project be accepted?

v. Describe the logic behind the NPV.

vi. Determine the PI for each of these projects. Should either project be accepted?

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

viii. What would happen to the NPV and PI for each project if the required rate of return increased? If the required rate of return decreased?

ix. Determine the IRR for each project. Should either project be accepted?

x. How does a change in the required rate of return affect the project’s internal rate of return?

b) You have also been asked for your views on another unrelated sets of projects. This project involves two mutually exclusive projects. Below is the project details:

Goggle Inc. is considering two investments with 1-year lives. The more expensive of the two will produce more savings. Assume these projects are mutually exclusive and that the required rate of return is 10 percent. Given the following free cash flows:

 i. Calculate the NPV for each project.

ii. Calculate the PI for each project.

iii. Calculate the IRR for each project.

iv. If there is no capital-rationing constraint, which project should be selected?

v. If there is a capital-rationing constraint, how should the decision be made?