Tax rate 35%
Capital Budgeting Decisions PRINCIPLES OF FINANCIAL MANAGEMENT
GROUP PROJECT (FINC 3310)
INSTRUCTOR: Dr. Hon-Jen A
aham Lin Yousuf Hayat FINC 3310 Section 1NTB Year 2020
1. Learning Objectives
(a) Develop proforma Project Income Statement Using Excel Spreadsheet
(b) Compute Net Project Cash flows, NPV, IRR and PayBack Period
(c) Develop Problem-Solving and Critical Thinking Skills
1) Life Period of the Equipment = 4 years 8) Sales for first year (1) $ 200,000
2) New equipment cost $ (950,000) 9) Sales increase per year 1%
3) Equipment ship & install cost $ (35,000) 10) Operating cost: $ (120,000)
4) Related start up cost $ (5,000) (60 Percent of Sales) -60%
5) Inventory increase $ 25,000 11) Depreciation (Straight Line)/YR $ 247,500
6) Accounts Payable increase $ 5,000 12) Tax rate 35%
7) Equip. Salvage Value Estimated $ 15,000 13) Cost of Capital (WACC) 10%
End of Year 4 (fully depreciated )
ESTIMATING Initial Outlay (Cash Flow, CFo, T= 0)
YEAR CF0 CF1 CF2 CF3 CF4
0 1 2 3 4
Investments:
1) Equipment cost $ (950,000)
2) Shipping and Install cost $ (35,000)
3) Start up expenses $ (5,000)
Total Basis Cost (1+2+3) $ (990,000)
4) Net Working Capital
Inventory Inc.- Acct. Payable Inc. $ (20,000) $ - 0 $ - 0 $ - 0 $ - 0
Total Initial Outlay $ (1,010,000)
Operations:
Revenue $ 200,000 $ 202,000 $ 204,020 $ 206,060
Operating Cost $ (120,000) $ (121,200) $ (122,412) $ (123,636)
Depreciation $ (247,500) $ (247,500) $ (247,500) $ (247,500)
EBIT $ (167,500) $ (166,700) $ (165,892) $ (165,076)
Taxes $ (58,625) $ (58,345) $ (58,062) $ (57,777)
Net Income (LOSS) $ (108,875) $ (108,355) $ (107,830) $ (107,299)
TAX SHIELD DUE TO LOSS
Add back Depreciation $ 247,500 $ 247,500 $ 247,500 $ 247,500
Total Operating Cash Flow $ 138,625 $ 139,145 $ 139,670 $ 140,201
Terminal (END of 4th YEAR)
1) Release of Working Capital $ - 0 $ - 0 $ - 0 $ 20,000
2) Salvage value (after tax) $ 9,750
Total $ 29,750
Project Net Cash Flows $ (1,010,000) $ 138,625 $ 139,145 $ 139,670 $ 169,951
NPV = ($547,967) IRR = -18.1% Payback= Never Payback
COST of CAPITAL (WACC) or DISCOUNT RATE OF THE PROJECT = 10%
Q#1 Would you accept the project based on NPV, IRR?
Would you accept the project based on Payback rule if project cut-off
period is 3 years?
Q#2 SENSITIVITY and SCENARIO ANALYIS.
Capital Budgeting (Investment ) Decisions
(a) Estimate NPV, IRR and Payback Period of the project if Marginal
Corporate Tax is reduced to 20%. Would you accept or reject the project?
Assume Straight-Line Depreciation.
(b) Estimate NPV, IRR and Payback Period of the project if Equipment is fully
depreciated in first year and tax rate is reduced to 20%. Would you
accept or reject the project?
( c) As a CFO of the firm, which of the above two scenario (a) or (b)
would you choose? Why?
Q#3 What are advantages and disadvantages of using only Payback method?
Tax rate 20%
Capital Budgeting Decisions PRINCIPLES OF FINANCIAL MANAGEMENT
GROUP PROJECT (FINC 3310)
INSTRUCTOR: Dr. Hon-Jen A
aham Lin Yousuf Hayat FINC 3310 Section 1NTB Year 2020
1. Learning Objectives
(a) Develop proforma Project Income Statement Using Excel Spreadsheet
(b) Compute Net Project Cash flows, NPV, IRR and PayBack Period
(c) Develop Problem-Solving and Critical Thinking Skills
1) Life Period of the Equipment = 4 years 8) Sales for first year (1) $ 200,000
2) New equipment cost $ (950,000) 9) Sales increase per year 1%
3) Equipment ship & install cost $ (35,000) 10) Operating cost: $ (120,000)
4) Related start up cost $ (5,000) (60 Percent of Sales) -60%
5) Inventory increase $ 25,000 11) Depreciation (Straight Line)/YR $ 247,500
6) Accounts Payable increase $ 5,000 12) Tax rate 20%
7) Equip. Salvage Value Estimated $ 15,000 13) Cost of Capital (WACC) 10%
End of Year 4 (fully depreciated )
ESTIMATING Initial Outlay (Cash Flow, CFo, T= 0)
YEAR CF0 CF1 CF2 CF3 CF4
0 1 2 3 4
Investments:
1) Equipment cost $ (950,000)
2) Shipping and Install cost $ (35,000)
3) Start up expenses $ (5,000)
Total Basis Cost (1+2+3) $ (990,000)
4) Net Working Capital
Inventory Inc.- Acct. Payable Inc. $ (20,000) $ - 0 $ - 0 $ - 0 $ - 0
Total Initial Outlay $ (1,010,000)
Operations:
Revenue $ 200,000 $ 202,000 $ 204,020 $ 206,060
Operating Cost $ (120,000) $ (121,200) $ (122,412) $ (123,636)
Depreciation $ (247,500) $ (247,500) $ (247,500) $ (247,500)
EBIT $ (167,500) $ (166,700) $ (165,892) $ (165,076)
Taxes $ (33,500) $ (33,340) $ (33,178) $ (33,015)
Net Income (LOSS) $ (134,000) $ (133,360) $ (132,714) $ (132,061)
TAX SHIELD DUE TO LOSS
Add back Depreciation $ 247,500 $ 247,500 $ 247,500 $ 247,500
Total Operating Cash Flow $ 113,500 $ 114,140 $ 114,786 $ 115,439
Terminal (END of 4th YEAR)
1) Release of Working Capital $ - 0 $ - 0 $ - 0 $ 20,000
2) Salvage value (after tax) $ 12,000
Total $ 32,000
Project Net Cash Flows $ (1,010,000) $ 113,500 $ 114,140 $ 114,786 $ 147,439
NPV = ($625,544) IRR = -23.0% Payback= Never Payback
COST of CAPITAL (WACC) or DISCOUNT RATE OF THE PROJECT = 10%
Q#1 Would you accept the project based on NPV, IRR?
Would you accept the project based on Payback rule if project cut-off
period is 3 years?
Q#2 SENSITIVITY and SCENARIO ANALYIS.
Capital Budgeting (Investment ) Decisions
(a) Estimate NPV, IRR and Payback Period of the project if Marginal
Corporate Tax is reduced to 20%. Would you accept or reject the project?
Assume Straight-Line Depreciation.
(b) Estimate NPV, IRR and Payback Period of the project if Equipment is fully
depreciated in first year and tax rate is reduced to 20%. Would you
accept or reject the project?
( c) As a CFO of the firm, which of the above two scenario (a) or (b)
would you choose? Why?
Q#3 What are advantages and disadvantages of using only Payback method?