Problem 12-20 Reinvestment rate assumption in capital budgeting [LO4] Turner Vid
ID: 2803085 • Letter: P
Question
Problem 12-20 Reinvestment rate assumption in capital budgeting [LO4] Turner Video will invest $62,500 in a project. The firm's cost of capital is 6 percent. The investment wil provide the following inflows. Use Appendix A for an approximate answer but calculate your final answer using the formula and financial calculator methods 1 $17,000 19,000 23,000 4 27,000 5 31,000 The internal rate of return is 22 percent t assumption of the net present value method is used, what will be the total value of come at the end of each year.) (Do not round a. If the reinvestmen the inflows 'after five years? (Assume the inflows intermediate calculations and round your answer to 2 decimal places.) Total value of inflows s 12955421 b. If the reinvestment assumption of the internal rate of return method is used, what will be the total value of the inflows after five years? (Use the given internal rate of return. Do not round intermediate calculations and round your answer to 2 decimal places.) Total value of inflows c. Which investment assumption is better? O Reinvestment assumption of IRR Reinvestment assumption or NPVExplanation / Answer
a.] Reinvestment assumption of the Cost of capital :-
Year Inflows Number of period Future value factor Future value of cash inflows
1 17000 4 (1+0.06)4 = 1.2625 21462.5
2 19000 3 (1+0.06)3 = 1.1910 22629
3 23000 2 (1+0.06)2 = 1.1236 25842.8
4 27000 1 (1+0.06)1 = 1.06 28620
5 31000 0 (1+0.06)0 = 1 31000
Total = $129554.3
b.] Reinvestment assumption of the Internal rate of return :-
Year Inflows Number of period Future value factor Future value of cash inflows
1 17000 4 (1+0.22)4 =2.2153 37660.1
2 19000 3 (1+0.22)3 =1.8158 34500.2
3 23000 2 (1+0.22)2 = 1.4884 34233.2
4 27000 1 (1+0.22)1 = 1.22 32940
5 31000 0 (1+0.22)0 = 1 31000
Total = $170333.5
c.] Reinvestment assumption of NPV , because it is more realistic and conservative assumption by taking cost of capital as reinvestment rate