please follow direstions listed inside attachments
All questions must be completed in one Word and/or Excel document and all work must be shown.
Your first assignment in your new position as assistant financial analyst at Johnson Products is to evaluate two new capital-budgeting proposals. Because this is your first assignment, you have been asked not only to provide a recommendation, but also to respond to a number of questions aimed at judging your understanding of the capital-budgeting process. This is a standard procedure for all new financial analysts at Johnson and will serve to determine whether you are moved directly into the capital-budgeting analysis department or are provided with remedial training. The memorandum you received outlining your assignment follows:
TO: The New Financial Analysts
FROM: Mr. J. Jackson, CEO, Johnson Products
RE: Capital-Budgeting Analysis
Provide an evaluation of two proposed projects, both with five-year expected lives and identical initial outlays of $110,000. Both of these projects involve additions to Johnson’s highly successful Delta product line, and as a result, the required rate of return on both projects has been established at 12 percent. The expected free cash flows from each project are as follows:
PROJECT A PROJECT B
Initial Outlay −$110,000 −$110,000
Year 1 20,000 40,000
Year 2 30,000 40,000
Year 3 40,000 40,000
Year 4 50,000 40,000
Year 5 70,000 40,000
In evaluating these projects, please respond to the following questions:
1. Why is the capital-budgeting process so important?
2. Why is it difficult to find exceptionally profitable projects?
3. What is the payback period on each project? If Johnson imposes a three-year maximum acceptable payback period, which of these projects should be accepted?
4. What are the criticisms of the payback period?
5. What is the discounted payback period for each of these projects? If Johnson requires a three-year maximum acceptable discounted payback period on new projects, which of these projects should be accepted?
6. What are the drawbacks or deficiencies of the discounted payback period? Do you feel either the payback or discounted payback period should be used to determine whether or not these projects should be accepted? Why or why not?
7. Determine the net present value for each of these projects. Should they be accepted?
8. Describe the logic behind the net present value.
9. Determine the profitability index for each of these projects. Should they be accepted?
10. What would happen to the net present value and profitability index for each project if the required rate of return increased? If the required rate of return decreased?
11. Determine the internal rate of return for each project. Should they be accepted?
12. How does a change in the required rate of return affect the project’s internal rate of return?
