Solution of the case:

Requirement 1:
In this case there are two computer engineer named Mike Chang and Joan Brown who worked in
a large chip manufacturer company as maintenance engineer. They pursued a dream of starting a
new venture by undertaking two different project based on estimation of future investment.
Project A, they needed to spend 1million dollar on plant, equipment and supplies. They would be
sell the product at dirt-cheap prices which will induce customer acceptance. The cash flows will
raise slowly and will be gained of the projection of fifth year. An innovative approach that they
had devised and patented could be sold to a large chip manufacturer for a decent sum.
Project B, immediately sell the patent for their innovative chip design to one of the established
chip markets for about $200,000. Their estimated investment for that project was 1.1million before
and after selling the patent, invest in some plant and equipment the net investment would be 9lac.
The project will brings up fast cash flows and become reduce in the next five years.
The main problem of both the projects are:
 Investment decision for initial investment are not appropriate in order to secure a stream
of benefits in future years.
 Their prefer payback period less than 3.5years and discounted payback period less than
4years whereas the project A will provide incremental cash flows and project B will
provide decremented cash flows.
 Lack of outline planned on analyzing the projects future errors and expenditure on the
fixed asset.
 Lack of economical evaluation, financial forecast, new and profitable use of estimated
investment funds where actual value can be lower or higher.

Requirement 2:
By analyzing the estimated cash flows that has been given on the case of two projects we can rank
them according to payback period, discounted payback period, net present value , IRR and MIRR
which are given below:
Project A,
Metrics Result Ranking Comment
Payback period 3.15 years Good Shorter than they expected but project B
provides gain faster and shorter than this.
Discounted payback 3.98 years Good Much number of years required to recover
period the investment from discounted cash
flows.
 Net present value $612,847 Better As positive NPV increase the value of the
firm and generates an extra return.
Internal rate of return 35.93% Good Less greater than the discount rate.
Modified internal rate of 32.04% Good cash flows are less reinvested at the cost
return of capital rather than project B

Project B,
Metrics Result Ranking Comment

Payback period 1.38 years Better Provides cash flows in very short
possible time.
Discounted payback 1.79 years Better Fewer number of years required to
period recover the investment from
discounted cash flows
Net present value $596206.24 Good It’s providing less NPV rather than
project A which generates less return.
Internal rate of return 55.07% Better Much greater than the discount rate

Modified internal rate of 32.84% Better cash flows reinvested much at the cost
return of capital rather than project A

Requirement 3:
In this case on a certain point both the entrepreneur are facing conflict regarding the investing
decision on which approach they can get more return. Joan believes that NPV is the best approach
on which Mike is still confuse and didn’t take it as good idea. Undoubtedly, there are other
approaches to determine whether the project will increase actual value of the firm but I prefer the
NPV most because:
 NPV is the sum of discounted cash flows of a project.
 If the NPV is positive, it generates an excess return and increases the value of the firm.
 NPV assumes that cash flows can be reinvested at the cost of capital.
On the other hand there are other approaches that also plays important role for taking decision such
as internal rate of return but it assumes that the firm has the opportunities to reinvest only at the
IRR and funds are available at the cost of capital.
However, the appropriate reinvestment rate assumption is the cost of capital. So I think it’s better
to use NPV for making decision.
Requirement 4:
After analyzing the two project I will recommend project A to Mike and Joan. Both the project has
their own pros and cons but to increase the value of the firm and generates an extra return project
A should be prioritize because,
On basis of NPV, both the projects has positive NPV but project A has higher NPV than project B
which means projects A can be reinvested at the cost of capital to generate excess return in future
years.
According to payback period and discounted payback period both the project will take shorter
time. Project B provides faster return but after same years the amount will be decremented. On the
other hand, the high rate of MIRR and IRR the project B can’t be consider as more worthy than
project A because the IRR and MIRR give decisions that not to maximize the value of a firm when
several investment options are being considered. Both the approaches does not actually measure
the various impacts of different investments in absolute terms. MIRR can also be difficult to
understand for people who do not have a financial background like Mike and Joan.

However, NPV often provides a more effective theoretical basis for selecting investments that
are mutually exclusive. That’s why I recommend project A to make the investment earnest in
future years.

Requirement 5:
Along with the other approaches of taking investment decision Net present value has some
limitation too:

 NPV requires the estimated cash flow of future investment to estimate cost of capital.

 If the two mutually exclusive projects has different investment amount than NPV method
is less preferable. A larger project that requires more money should have a higher NPV,
but that doesn't necessarily make it a better investment, compared to a smaller project.
Frequently, a company has other qualitative factors to consider

 The NPV approach is difficult to apply when comparing projects that have different time
periods

So, after all this limitation my further recommendation of doing the analysis would be payback
period because Payback period gives an idea about how long funds will be tied up in a project and
also provide indication of the liquidity of the project. Shorter the payback, greater the liquidity of
the project.
.

Case study on ‘Capital budgeting’

Date of submission: 23- March -2019

Submitted to:

Md. Kamrul Islam

Lecturer
Notre Dame University Bangladesh

Submitted by:

Ashrafuz Zaman
Jubair
ID: 5-16010101