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Complete the following homework scenario:
·
Required:

Compare the results of the three (3) methods by quality of information for
decision making. Using what you have learned about the three (3) methods,
identify the best project by the criteria of long term increase in value. (You
do not need to do further research.) Convey your understanding of the Time
Value of Money principles used or not used in the three (3) methods. Review the
video titled “NPV, IRR, MIRR for Mac and PC Excel” (located athttps://www.youtube.com/watch?v=C7CryVgFbBc and
previously listed in Week 4) to help you understand the foundational
concepts:

Scenario Information:

Assume that two gas stations are for sale with the following cash flows; CF1 is
the Cash Flow in the first year, and CF2 is the Cash Flow in the second year.
This is the time line and data used in calculating the Payback Period, Net
Present Value, and Internal Rate of Return. The calculations are done for you.
Your task is to select the best project and explain your decision. The methods
are presented and the decision each indicates is given below.

Investment

Sales Price

CF1

CF2

Gas
Station A

$50,000

$0

$100,000

Gas
Station B

$50,000

$50,000

$25,000

·

Three (3) Capital Budgeting Methods are presented:
1.
Payback Period: Gas Station A
is paid back in 2 years; CF1 in year 1, and CF2 in year 2. Gas Station B is
paid back in one (1) year. According to the payback period, when given the
choice between two mutually exclusive projects, the investment paid back in the
shortest time is selected.
2.
Net Present Value: Consider the
gas station example above under the NPV method, and a discount rate of 10%:

NPVgas station A = $100,000/(1+.10)2 – $50,000 =$32,644

NPVgas station B = $50,000/(1+.10) +
$25,000/(1+.10)2 – $50,000 =$16,115
3.
Internal Rate of
Return: Assuming 10% is the cost of funds; the IRR for Station A
is 41.421%.; for Station B, 36.602.

Summary of the Three (3) Methods:
o Gas Station B
should be selected, as the investment is returned in 1 period rather than 2
periods required for Gas Station A.
o Under the NPV
criteria, however, the decision favors gas station A, as it has the higher net
present value. NPV is a measure of the value of the investment.
o The IRR method
favors Gas Station A. as it has a higher return, exceeding the cost of funds
(10%) by the highest return.

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