Tutorial 3 Sheet

The German University in Cairo (GUC) Winter 2023
Faculty of Management Technology Dr. Hadeer Mounir

Finance Department Corporate Finance FINC 504
Tutorial 3
Chapter 10: Capital Budgeting Techniques
1. Classification of expenditures: Given the following list of outlays, indicate whether

each is normally considered a capital or an operating expenditure:
a) An outlay of $20,000 to purchase patent rights from an investor.
b) An outlay of $80,000 for a major research and development program.
c) An $80,000 investment in portfolio marketable securities.
d) A $300 outlay for an office machine.
e) An outlay of $2,000 for a new machine tool.
f) An outlay of $24,000 for a new building.
g) An outlay of $1,000 for marketing research report.
2. Basic terminology: A firm is considering the following three separate situations. For
each situation, indicate:
a) Whether the projects involved are independent or mutually exclusive.
b) Whether the availability of funds is unlimited or capital rationing exists.
c) Whether accept-reject or ranking decisions are required.
d) Whether each project’s cash flows are conventional or non- conventional.
Situation A: Build either a small office building or a convenience store on a parcel of land
located in a high-traffic area. Adequate funding is available, and both projects are known to be
acceptable. The office building requires an initial investment of $620,000 and is expected to
provide operating cash inflows of $40,000 per year for 20 years. The convenience store is
expected to cost $500,000 and to provide a growing stream of operating cash inflows over its 20-
year life. The initial operating cash inflow is $20,000, and it will increase by 5% each year.
Situation B: Replace a machine with a new one that requires a $60,000 initial investment and
will provide operating cash inflows of $10,000 per year for the first 5 years. At the end of year 5,
a machine overhaul costing $20,000 will be required. After it is completed, expected operating
cash inflows will be $10,000 in year 6; $7,000 in year 7; $4,000 in year 8; and $1,000 in year 9, at
the end of which the machine will be scrapped.
Situation C: Invest in any or all of the four machines whose relevant cash flows are given in the
following table. The firm has $500,000 budgeted to fund these machines, all of which are known
to be acceptable. The initial investment for each machine is $250,000.
The German University in Cairo (GUC) Winter 2023
Faculty of Management Technology Dr. Hadeer Mounir
Finance Department Corporate Finance FINC 504
3. Shell Camping Gear, Inc., is considering two mutually exclusive projects. Each requires
an initial investment of $100,000. John Shell, president of the company, has set a
maximum payback period of 4 years. The after-tax cash inflows associated with each
project are shown in the following table:
a. Determine the payback period of each project.

b. Because they are mutually exclusive, Shell must choose one. Which should the
company invest in?
c. Explain why one of the projects is a better choice than the other.
4. NPV for varying costs of capital Dane Cosmetics is evaluating a new fragrance mixing
machine. The machine requires an initial investment of $24,000 and will generate after-tax cash
inflows of $5,000 per year for 8 years. For each of the costs of capital listed, (1) calculate the net
present value (NPV), (2) indicate whether to accept or reject the machine, and (3) explain your
decision.
a. The cost of capital is 10%.
b. The cost of capital is 12%.
c. The cost of capital is 14%.
5. Projects A and B, of equal risk, are alternatives for expanding Rosa Company’s capacity. The
firm’s cost of capital is 13%. The cash flows for each project are shown in the following table.
Project A Project B
Initial Investment (CF0) $80,000 50,000
Year (t) Cash inflows (CFt)
1 $15,000 $15,000
2 20,000 15,000
3 25,000 15,000
4 30,000 15,000
5 35,000 15,000
a. Calculate each project’s payback period.
b. Calculate the net present value (NPV) for each project.
c. Summarize the preferences dictated by each measure, and indicate which project you would
recommend if the payback period is determined to be maximum 3.5 years. Explain why.

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The German University in Cairo (GUC) Winter 2023

Faculty of Management Technology Dr. Hadeer Mounir

1. Classification of expenditures: Given the following list of outlays, indicate whether

a. Determine the payback period of each project.

Initial Investment (CF0) $80,000 50,000

Year (t) Cash inflows (CFt)

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