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Question 6: Capital Budgeting

Meat and Salad Limited is an international producer of frozen drinks and food. The company is based on the island of Beefcake in the Atlantic Ocean.

The company is approaching the end of its financial year, and the board of directors are seeking to decide on the capital budget for the forthcoming year, and the capital expenditure items the company may invest into.

The chief financial officer (CFO) has presented the board with the following list of five major capital expenditure projects for consideration with the initial outlay and projected annual after-tax cash flows for each project.

	Project B	Project R	Project A	Project V	Project E
Initial Outlay	$36,000,000.00	$59,000,000.00	$34,000,000.00	$31,000,000.00	$82,500,000.00
Life of Project	4 Years	5 Years	4 Years	4 Years	6 Years
Annual After-Tax Cash Flow
Year 1	$14,000,000.00	$21,000,000.00	$21,000,000.00	$8,000,000.00	$12,000,000.00
Year 2	$11,000,000.00	$22,000,000.00	$9,000,000.00	$11,000,000.00	$18,000,000.00
Year 3	$16,000,000.00	$18,000,000.00	$5,000,000.00	$14,000,000.00	$24,000,000.00
Year 4	$15,000,000.00	$17,000,000.00	$9,000,000.00	$17,000,000.00	$30,000,000.00
Year 5		$22,000,000.00			$35,000,000.00
Year 6					$34,750,000.00

The market value of equity of the company is $50,000,000 and the market value of debt is $75,000,000. The cost of capital is 13.25%.

Required:

1. Calculate the discounted payback period for Project V. The company requires a minimum accounting payback period of 2.25 years. Would Project V be accepted (ignore all other projects)?
2. Calculate the profitability index value for Project B. Would Project B be accepted (ignore all other projects)?
3. Assume that the company has a capital budget of $67,000,000 for the forthcoming year. Also, assume that the company can only select from Project B, Project A and Project V. All these projects are assumed to be independent. Calculate the NPV of each and based on that project (or projects) should the company select. Justify your answer.
4. Assume company wish to select between Project R and Project E. Both projects are mutually exclusive. Based on appropriate calculation techniques, which project would be selected. Show all calculations.

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