Your boss, the chief financial officer (CFO) for Dream Analytics Inc., has just handed you the estimated cash flows for two proposed projects. Project A involves adding a new item to the firm’s Digital Intelligence software line. It would take some time to build up the market for this product, so the cash inflows would increase over time. Project B involves an add-on to an existing Global Integration self-guided software line, and its cash flows would decrease over time. Both projects have 4-year lives because Dream Analytics is planning to introduce an entirely new Artificial Intelligence software product at that time. The budget is $25,000 for the initial investment. Here are the estimated net cash flows (in thousands of dollars): Expected Net Cash Flows Year Project A Project B 0 $(25,000) $(25,000) 1 12500 9000 2 9900 23000 3 21000 11000 4 14000 1500 The CFO also made subjective risk assessments of each project, and he concluded that the projects both have risk characteristics that are similar to the firm’s average project. Dream Analytics’ required rate of return is 9% (use this rate for your financing and reinvestment rate). You must now determine which of the projects should be accepted. Start by answering the following questions: a. What is capital budgeting? Are there any similarities between a firm’s capital budgeting decisions and an individual’s investment decisions? b. What is the difference between independent and mutually exclusive projects? Between projects with conventional cash flows and projects with unconventional cash flows? c. (1) Define the term net present value (NPV). What is each project’s NPV? (2) What is the rationale behind the NPV method? According to NPV, which project or projects should be accepted if they are independent? Mutually exclusive? d. (1) Define the term internal rate of return (IRR). What is each project’s IRR? (2) Which project should be accepted? Explain Why? f. (1) Define the term modified internal rate of return (MIRR). What is each project’s MIRR? (2) What is the rationale behind the MIRR method? According to MIRR, which project or projects should be accepted? Explain Why?
Your boss, the chief financial officer (CFO) for Dream Analytics Inc., has just handed you the estimated cash flows for two proposed projects. Project A involves adding a new item to the firm’s Digital Intelligence software line. It would take some time to build up the market for this product, so the
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