Capital Expenditures Essay

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Capital Expenditures

Capital expenditures have a significant impact on the financial performance of the firm; therefore, criteria for selecting projects must be evaluated with great care. Of the two corporations the firm is deciding to acquire, Corporation B is clearly the better investment as shown in Table 1 supported by the following data: net present value
(NPV), internal rate of return (IRR), payback period, profitability index (PI), discounted payback period, and modified internal rate of return (MIRR) in addition to 5 year projections of income and cash flows. The 5 year projections of both Corporations A and B’s income statements and cash flows indicate that between the two corporations,
Corporation B will maximize
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IRR is not a good measure of capital budgeting decision by itself given that it may give ambiguous results. In addition, it is critical to choose the appropriate discount rate relative to the riskiness of the project’s cash flows to have the assurance that the present value of the investment will in fact be realized by the firm.
It is worth noting that if the cash flows are discounted at the IRR rate, NPV will be zero.

The MIRR or Modified Internal Rate of Return is yet another criterion for capital budgeting decision. It is basically the Internal Rate of
Return adjusted for negative cash flows. MIRR better reflects the profitability of a project as it assumes that all cash flows are reinvested at the firm’s cost of capital, whereas the IRR assumes the cash flows from the project are reinvested at the IRR. Again, while acquisitions of either corporation will benefit the firm, the MIRR supports the acquisition of Corporation B over Corporation A since
Corporation B has a higher MIRR than Corporation A.

The profitability index (PI) is defined as the ratio of the present value of the future free cash flows to the initial outlay. Corporation
A provides a PI of 8.39% while corporation B provides a PI of 16.10%.
Since profitability indexes are greater than 1.0 for both corporations, acquisition of either

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