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Capital Budgeting Decisions
INSTRUCTOR:
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 $ (223,500) 9) Sales increase per year 5%
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
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 $ (223,500)
2) Shipping and Install cost $ (35,000)
3) Start up expenses $ (5,000)
Total Basis Cost (1+2+3) $ (263,500)
4) Net Working Capital
Inventory Inc.- Acct. Payable Inc. $ (20,000) $ - 0 $ - 0 $ - 0 $ - 0
Total Initial Outlay
Operations:
Revenue
Operating Cost
Depreciation
EBIT
Taxes
Net Income (LOSS) XXXXXX XXXXX XXXXX XXXXX
TAX SHIELD DUE TO LOSS
Add back Depreciation
Total Operating Cash Flow XXXXX XXXXX XXXXX XXXXX
Terminal (END of 4th YEAR)
1) Release of Working Capital $ - 0 $ - 0 $ - 0 $ 20,000
2) Salvage value (after tax)
Total XXXXXX
Project Net Cash Flows $ - 0 $ - 0 $ - 0 $ - 0 $
NPV = IRR = 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?
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