Your first assignment in your new position as assistantfinancial analyst at Caledonia Products is to evaluate two new?capital-budgeting proposals. Because this is your first?assignment, you have been asked not only to provide arecommendation but also to respond to a number of questions aimedat assessing your understanding of the? capital-budgeting process.This is a standard procedure for all new financial analysts at?Caledonia, and it will serve to determine whether you are moveddirectly into the? capital-budgeting analysis department or areprovided with remedial training. The memorandum you receivedoutlining your assignment? follows:

?To: New Financial Analysts

?From: Mr. V.? Morrison, CEO, Caledonia Products

?Re: Capital-Budgeting Analysis

Provide an evaluation of two proposed? projects, both with

55?-year

expected lives and identical initial outlays of

?$150 comma 000150,000.

Both of these projects involve additions to? Caledonia's highlysuccessful Avalon product? line, and as a? result, the requiredrate of return on both projects has been established at

1313

percent. The expected free cash flows from each project areshown in the popup? window:

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.

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

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

b. Why is it difficult to find exceptionally profitable?projects?

c. What is the payback period on each? project? If Caledoniaimposes a

44?-year

maximum acceptable payback? period, which of these projectsshould be? accepted?

d. What are the criticisms of the payback? period?

e. Determine the NPV for each of these projects. Should eitherproject be? accepted?

f. Describe the logic behind the

NPV.

g. Determine the PI for each of these projects. Should eitherproject be? accepted?

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

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

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

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

l. What reinvestment rate assumptions are implicitly made by theNPV and IRR ?methods? Which one is? better?

	PROJECT A		PROJECT B		Copy to Clipboard + Open in Excel +
Initial outlay	??$150,000		??$150,000
Inflow year 1	?????? 10,000		?????? 40,000
Inflow year 2	?????? 30,000		?????? 40,000
Inflow year 3	?????? 30,000		?????? 40,000
Inflow year 4	?????? 50,000		?????? 40,000
Inflow year 5	?????? 70,000		??????40,000