Essay about Caledonia Mini Case

928 Words Aug 2nd, 2012 4 Pages
a. Should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or total profits?
Caledonia should focus on cash flows, not accounting profits. Free cash flows are able to be reinvested, whereas accounting profits are shown when they are earned, not when the cash is actually received.
The company should be interested in incremental after-tax cash flows. The incremental cash flow will allow Caledonia to see the profits or losses of a project by comparing cash flows with and without the project on an after tax basis.
b. How does depreciation affect free cash flows?
Depreciation lowers
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Draw a cash flow diagram for this project.

h. What is its net present value?
NPV is $17,336,522
Year 1 $4,271,304.35
Year 2 $6,410,434.78
Year 3 $7,266,086.96
Year 4 $4,699,130.43
Year 5 $2,789,565.22
Total $25,436,521.74
Intial Outlay ($8,100,000)
NPV $17,336,522

i. What is its internal rate of return?
IRR is 33%
Year 1 $4,271,304.35
Year 2 $6,410,434.78
Year 3 $7,266,086.96
Year 4 $4,699,130.43
Year 5 $2,789,565.22
Intial Outlay ($8,100,000)
IRR -33%

j. Should the project be accepted? Why or why not?
Yes. The NPV is greater than zero and the IRR is greater than the required rate of return of 15%.
k. In capital budgeting, risk can be measured from three perspectives. What are those three measures of a project’s risk?
Project standing alone risk. This is the amount of risk ignoring that most of the risk will be diversified as the project is combined with the firms other assets and projects.
Contribution to firm risk. This is the amount of risk the project contributes to the firm.With this measure, we consider the fact that some of the risk will be diversified away as the project is combined with other projects and assets. However, we ignore the effects to the shareholders.
Systematic risk. This is the

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