Capital Budgeting
Capital Budgeting Process
1). Asset Investment
2). Depreciable Life
3). Net Income: Revenues - Operating Expenses
4). Net Cash Flow: Depreciation / Working Capital / Disposal (Salvage Value)
5). Return Analysis: Net Present Value / Internal Rate of Return / Profitability Index / Payback
6). Risk Analysis: Scenario / Sensitivity
WACC
Weighted Average Cost of Capital Chapter 9
Debt to Assets % = 60%
Tax Rate: 30%
Interest Rate on Debt 9% Cost of
Debt AT 6.30%
Risk Free Interest Rate 2.50% Cost of
Market Rate of Return 10% Equity
CAPM 12.63%
Firm Beta 1.35
WACC: Debt % Equity % WACC
W debt 60% 6.30% 3.78%
W equity 40% 12.63% 5.05%
8.83%
&"-,Bold"&12Week 6
In Class Review
Base Analysis
Capital Budget Analysis
Text Ref: XXXXXXXXXX Average Year: 0 1 2 3 4 5 6 7 8 9 10 Total
Inputs Base Case
Equipment Cost $ 1,000,000 Investment: $ (1,000,000)
Salvage Value, Year 10 $ 50,000
Depreciation Per Year $ 100,000 Sales $ 500,000 $ 512,500 $ 525,312 $ 538,445 $ 551,906 $ 565,704 $ 579,847 $ 594,343 $ 609,201 $ 624,431 $ 5,601,691
Units Sold Every Year 25,000
Sales price per unit, Year 1 $ XXXXXXXXXX Expenses:
Annual change in sales price, after Year 1 2.5% VC $ 200,000 $ 204,000 $ 208,080 $ 212,242 $ 216,486 $ 220,816 $ 225,232 $ 229,737 $ 234,332 $ 239,019 $ 2,189,944
Variable cost per unit (VC), Year 1 $ 8.00 FC $ 50,000 $ 50,500 $ 51,005 $ 51,515 $ 52,030 $ 52,551 $ 53,076 $ 53,607 $ 54,143 $ 54,684 $ 523,111
Annual change in VC, after Year 1 2.0% Depreciation $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 1,000,000
Fixed Cost (FC), Year 1 $ 50,000 EBT $ 150,000 $ 158,000 $ 166,227 $ 174,689 $ 183,390 $ 192,337 $ 201,538 $ 210,999 $ 220,727 $ 230,729 $ 1,888,636
Annual change in FC, after Year 1 1.0%
Project WACC 8.83% Tax (30%) $ 45,000 $ 47,400 $ 49,868 $ 52,407 $ 55,017 $ 57,701 $ 60,461 $ 63,300 $ 66,218 $ 69,219 $ 566,591
Tax Rate 30.0% Net Income $ 105,000 $ 110,600 $ 116,359 $ 122,282 $ 128,373 $ 134,636 $ 141,077 $ 147,699 $ 154,509 $ 161,510 $ 1,322,045
Working Capital as % of next year's sales 12.0%
Salvage Value $ 35,000 $ 35,000
Risk Analysis Depreciation $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 1,000,000
Scenario Analysis Text Ref: XXXXXXXXXX NOWC $ (60,000) $ (1,500) $ (1,537) $ (1,576) $ (1,615) $ (1,656) $ (1,697) $ (1,740) $ (1,783) $ (1,828) $ 74,932 $ 60,000
Weak Sales = 12,500 units (25% probability) Net Cash Flow $ (1,060,000) $ 203,500 $ 209,062 $ 214,783 $ 220,667 $ 226,717 $ 232,939 $ 239,337 $ 245,916 $ 252,681 $ 371,442 $ 2,417,045
Average Sales = 25,000 units (50% probability) DCF $1,510,832
Strong Sales = 35,000 units (25% probability) NPV $450,832 Return Analysis in Dollars $500,000
IRR 17.03% Return Analysis in Percentage 18.00%
Sensitivity Analysis text Ref: XXXXXXXXXX PI 1.43 Return Analysis in Ratio 1.5
Variables: Payback Years 4.94 Return Analysis in Years (Time) 4 Years
XXXXXXXXXXSales Price / unit $ (856,500) $ (647,438) $ (432,654) $ (211,987) $ 14,730 $ 247,669
XXXXXXXXXXVariable Cost / unit 0.94
XXXXXXXXXXWACC
Deviations: +/- 5%, 10%, 15%
Risk Analysis
Average Strong Weak
Scenario 25,000 35,000 12,500
50% 25% 25%
NPV $450,832 $1,041,626 ($287,269)
Probability $ 225,416 $ 260,407 ($71,817) $ 414,005
Sensitivity
$20.00 $8.00 8.83%
Deviation SP/Unit VC/Unit WACC
-15% $ 82,628 $ 597,489 $ 550,566
-10% $ 205,363 $ 548,604 $ 516,248
-5% $ 328,098 $ 499,718 $ 483,017
0% $ 450,832 $ 450,832 $ 450,832
5% $ 573,567 $ 401,947 $ 419,653
10% $ 696,302 $ 353,601 $ 389,439
15% $ 819,037 $ 304,176 $ 360,156
Range $ 736,409 $ 293,313 $ 190,410
SP/Unit -0.15 -0.1 -0.05 0 0.05 0.1 0.15 82628 205363 328098 450832 573567 696302 819037 VC/Unit -0.15 -0.1 -0.05 0 0.05 0.1 0.15 597489 548604 499718 450832 401947 353601 304176 WACC -0.15 -0.1 -0.05 0 0.05 0.1 0.15 550566 516248 483017 450832 419653 389439 360156
Question 10-7
Year Project A 0 1 2 3
Net Cash Flow $ (15,000,000) $ 5,000,000 $ 10,000,000 $ 20,000,000
Cost of Capital 5% DCF: $31,108,952
NPV: $16,108,952
Cost of Capital 10% DCF: $27,836,213
NPV: $12,836,213
Cost of Capital 15% DCF: $25,059,587
NPV: $10,059,587
IRR: 43.97%
Year Project B 0 1 2 3
Net Cash Flow $ (15,000,000) $ 20,000,000 $ 10,000,000 $ 6,000,000
Cost of Capital 5% DCF: $33,300,939
NPV: $18,300,939
Cost of Capital 10% DCF: $30,954,170
NPV: $15,954,170
Cost of Capital 15% DCF: $28,897,838
NPV: $13,897,838
IRR: 82.03%
Sensitivity Analysis
Capital Budget Analysis
Text Ref: XXXXXXXXXX Average Year: 0 1 2 3 4 5 6 7 8 9 10 Total
Inputs Base Case
Equipment Cost $ 1,000,000 Investment: $ (1,000,000)
Salvage Value, Year 10 $ 50,000
Depreciation Per Year $ 100,000 Sales $ 500,000 $ 512,500 $ 525,312 $ 538,445 $ 551,906 $ 565,704 $ 579,847 $ 594,343 $ 609,201 $ 624,431 $ 5,601,691
Units Sold Every Year 25,000
Sales price per unit, Year 1 $ XXXXXXXXXX Expenses:
Annual change in sales price, after Year 1 2.5% VC $ 200,000 $ 204,000 $ 208,080 $ 212,242 $ 216,486 $ 220,816 $ 225,232 $ 229,737 $ 234,332 $ 239,019 $ 2,189,944
Variable cost per unit (VC), Year 1 $ 8.00 FC $ 50,000 $ 50,500 $ 51,005 $ 51,515 $ 52,030 $ 52,551 $ 53,076 $ 53,607 $ 54,143 $ 54,684 $ 523,111
Annual change in VC, after Year 1 2.0% Depreciation $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 1,000,000
Fixed Cost (FC), Year 1 $ 50,000 EBT $ 150,000 $ 158,000 $ 166,227 $ 174,689 $ 183,390 $ 192,337 $ 201,538 $ 210,999 $ 220,727 $ 230,729 $ 1,888,636
Annual change in FC, after Year 1 1.0%
Project WACC 8.83% Tax (30%) $ 45,000 $ 47,400 $ 49,868 $ 52,407 $ 55,017 $ 57,701 $ 60,461 $ 63,300 $ 66,218 $ 69,219 $ 566,591
Tax Rate 30.0% Net Income $ 105,000 $ 110,600 $ 116,359 $ 122,282 $ 128,373 $ 134,636 $ 141,077 $ 147,699 $ 154,509 $ 161,510 $ 1,322,045
Working Capital as % of next year's sales 12.0%
Salvage Value $ 35,000 $ 35,000
Risk Analysis Depreciation $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 1,000,000
Scenario Analysis Text Ref: XXXXXXXXXX NOWC $ (60,000) $ (1,500) $ (1,537) $ (1,576) $ (1,615) $ (1,656) $ (1,697) $ (1,740) $ (1,783) $ (1,828) $ 74,932 $ 60,000
Weak Sales = 12,500 units (25% probability) Net Cash Flow $ (1,060,000) $ 203,500 $ 209,062 $ 214,783 $ 220,667 $ 226,717 $ 232,939 $ 239,337 $ 245,916 $ 252,681 $ 371,442 $ 2,417,045
Average Sales = 25,000 units (50% probability) DCF $1,510,832
Strong Sales = 35,000 units (25% probability) NPV $450,832
IRR 17.03%
Sensitivity Analysis text Ref: XXXXXXXXXX PI 1.43
Variables: Payback Years 4.94 $ (856,500) $ (647,438) $ (432,654) $ (211,987) $ 14,730
XXXXXXXXXXSales Price / unit 0.94
XXXXXXXXXXVariable Cost / unit
XXXXXXXXXXWACC
Deviations: +/- 5%, 10%, 15%