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The Basics of Capital Budgeting

Integrated Case

11-24

Allied Components Company

Basics of Capital Budgeting

You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with products from Daimler, Chrysler, Ford, and other automakers. Your boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm’s ignition system line; it would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3-year lives, because Allied is planning to introduce entirely new models after 3 years.

Here are the projects’ net cash flows (in thousands of dollars): 0 1 2 3 | | | |

Project L -100 10 60 80

Project S -100 70 50 20

Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows.

The CFO also made subjective risk assessments of each project, and he concluded that both projects have risk characteristics that are similar to the firm’s average project. Allied’s WACC is 10%. You must determine whether one or both of the projects should be accepted.

A. What is capital budgeting? Are there any similarities between a firm’s capital budgeting decisions and an individual’s investment decisions? Capital budgeting is the process of analyzing additions to fixed assets. capital budgeting is important because, more than anything else, fixed asset investment decisions chart a company’s course for the future. conceptually, the capital budgeting process is identical to the decision process used by individuals making investment decisions. these steps are involved. 1.Estimate…...

...CHAPTER 7 INTRODUCTION TO CAPITAL BUDGETING 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 Overview 159 The NPV Rule for Judging Investments and Projects 159 The IRR Rule for Judging Investments 161 NPV or IRR, Which to Use? 162 The “Yes–No” Criterion: When Do IRR and NPV Give the Same Answer? 163 Do NPV and IRR Produce the Same Project Rankings? 164 Capital Budgeting Principle: Ignore Sunk Costs and Consider Only Marginal Cash Flows 168 Capital Budgeting Principle: Don’t Forget the Effects of Taxes—Sally and Dave’s Condo Investment 169 Capital Budgeting and Salvage Values 176 Capital Budgeting Principle: Don’t Forget the Cost of Foregone Opportunities 180 In-House Copying or Outsourcing? A Mini-case Illustrating Foregone Opportunity Costs 181 Accelerated Depreciation 184 Conclusion 185 Exercises 186 158 0195301501_158-192_ch7.qxd 11/3/05 12:47 PM Page 159 CHAPTER 7 Introduction to Capital Budgeting 159 OVERVIEW Capital budgeting is ﬁnance terminology for the process of deciding whether or not to undertake an investment project. There are two standard concepts used in capital budgeting: net present value (NPV) and internal rate of return (IRR). Both of these concepts were introduced in Chapter 5; in this chapter we discuss their application to capital budgeting. Here are some of the topics covered: • Should you undertake a speciﬁc project? We call this the “yes–no” decision, and we show how both NPV and IRR answer this question. • Ranking projects: If......

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... CAPITAL BUDGETING IN THE PRIVATE SECTOR TABLE OF CONTENT Title page Approval page Dedication Acknowledgement Abstract Table of content CHAPTER ONE 1. INTRODUCTIONS OF “CAPITAL BUDGETING IN THE PRIVATE SECTOR” 1.1 Statement of the problem 1.2 Objective of study 1.3 Significance of study 1.4 Statement of the hypothesis 1.5 Scope of the study 1.6 Definitions of terms CHAPTER TWO 2. REVIEW OF THE RELATED LITERATURE OF “CAPITAL BUDGETING IN THE PRIVATE SECTOR” 2.1 Meaning of capital budgeting decision 2.2 Importance of capital budgeting decision 2.3 Types of capital budgeting decision 2.4 Problems 2.5 Analysis of capital project 2.6 Deterring the cash flow 2.7 Techniques used in capital budgeting decision 2.7.1 Payback method 2.7.2 Net present value 2.7.3 Internal rate of return 2.7.4 Accounting rate of return 8. Ranking of investment proposal CHAPTER THREE 3. RESEARCH DESIGN AND METHODOLOGY OF “CAPITAL BUDGETING IN THE PRIVATE SECTOR” 3.1 Source of data 3.2 Primary 3.3 Secondary data 3.4 Sample used 3.5 Method of investigation CHAPTER FOUR 4. DATA ANALYSIS AND INTERPRETATION OF “CAPITAL BUDGETING IN THE PRIVATE SECTOR” 4.1 Data presentation and analysis 4.3 Test of hypothesis CHAPTER FIVE 5. SUMMARY, CONCLUSION AND RECOMMENDATION OF “CAPITAL BUDGETING IN THE PRIVATE SECTOR” 5.1 Summary of the findings 5.2 Conclusion 5.3 Recommendation Bibliography Appendix Questionnaire *** Read the following......

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...Capital Budgeting Case Study Atilano Bonilla QRB/501 October 14, 2013 Vladimir Crk Capital Budgeting Case Study The authors of this paper will analyze and interpret the answers to the Capital Budgeting Case Study presented in Week 6’s material of the Quantitative Reasoning for Business course. The paper presents the rationale behind the Net Present Value (NPV) and Internal Rate of Return (IRR) results, describes the relationship between the two and explains the reasons behind the acquisition recommendation (e) in the Microsoft Excel spreadsheet. Analyzing the Results The case study presents two corporations (A and B) with different revenue values and expenses as well as variable depreciation expenses, tax rates and discount rates. Members of the team computed both corporations’ cash flow, NPV and IRR value using a Microsoft Excel spreadsheet. The net present value (NPV) of an investment proposal is equal to the present value of its annual free cash flows less the investment’s initial outlay. Whenever the project’s NPV is greater than or equal to zero, we will accept the project; whenever the NPV is negative, we will reject the project. (Keown, 2014. p. 310) On the other hand Keown (2014) points out that “the internal rate of return is defined as the discount rate that equates the present value of the project’s free cash flows with the project’s initial cash outlay.” In effect, the NPV method implicitly assumes that cash flows......

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...Paper Elizabeth Scott BBA/3301 January 13, 2013 Nchacha Etta Capital Budgeting When evaluating capital budgeting projects, the internal rate of return (IRR) and the net present value (NPV) methods are two major approaches used. IRR and NPV are the most widely used in capital budgeting. One other approach is the profitability index (PI) is essentially a variation on the NPV method. A question might be if these always give the same solutions to the problems. The answer here is no. This paper will explore these different capital budgeting techniques. This paper will also compare and contrast each of the techniques with an emphasis on comparative strengths and weaknesses. The net present value (NPV) applies to the analysis of projects. Calculate the present value of each of a project’s cash flows and add them together, using the net present value technique. This gives the result of the net present value of the project, usually referred to as the NPV (Lasher, 2011). A project’s net present value is the new effect that the undertaking is expected to have on the value of the firm. A capital spending program which maximizes the NPV of projects undertaken will contribute to maximizing shareholder wealth. According to Lasher (2011), it is the direct link to shareholder wealth maximization that makes MPV the most theoretically correct capital budgeting technique. The internal rate of return, instead of comparing present value dollar......

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...Capital Budgeting Case Shawn P. Oeser QRB/501 October 7, 2013 David Gobeli Capital Budgeting Case For the final week of QRB/501 we were asked to complete a Capital Budgeting Case based on two possible corporations for our company. Based on the 5 year projected income statement, 5 year projected cash flow, Net Present Value (NPV), and Internal Rate of Return (IRR); we were to determine which company would be the wiser acquisition. After completing the analysis it was determined that Corporation B would be the proper choice of the two corporations. According to our text the NPV, “of an investment proposal is equal to the present value of its annual free cash flows less the investment’s initial outlay” (Keown, Martin, & Petty, 2014, p. 310), therefore determining the NPV value of each company is a step needed in determining the whether either company was worth the initial investment. The next step was determining the companies IRR, which is defined in our text as, “the internal rate of return is defined as the discount rate that equates the present value of the project’s free cash flows with the project’s initial cash outlay” (Keown, Martin, & Petty, 2014, p. 310). Yet these were not the only determining factors, we also were required to look at the projected 5-year cash flow and the projected 5-year income statement. When comparing the NPV of both corporations it was clear that the NPV of Corporation B was almost double that of Corporation A at $36,262.58......

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...Capital Budgeting Introduction Capital budgeting is the process of evaluating and selecting long-term investments that are consistent with the firm's goal of maximizing owner wealth. A firm using capital budgeting, their goal is to see if there fixed income will cover itself for profit. Fixed incomes are things such as land, plant and equipment. When a firm using a machine to produce its good or service. They most of the time what the machine to produce the amount that they paid for the machine and more. The capital expenditure is the outlay of fund that a firm expects to produce and benefit with in a one year. The Capital Budgeting Process When approaching the problem of trying to the measure capital budgeting. The first step in capital budgeting is the Proposal generation. The proposals are made at all levels within a business organization and are reviewed by finance personal. The Second step in the process in the review and analysis. The formal review and analysis is performed to assess the appropriateness of proposals and evaluate their economic viability. Once the analysis is complete, a summary report is summated to decision makers. The third step in the process will be the Decision making. Firms typically delegate capital expenditure decision making on the basis of dollar limits. The board of directors must authorize expenditures beyond a certain amount. Often plant manager are given authority to make decisions necessary to keep the production line is moving....

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...Handouts for Corporate Finance 1 Capital Budgeting Introduction A logical prerequisite to the analysis of investment opportunities is the creation of investment opportunities. Unlike the field of investments, where the analyst more or less takes the investment opportunity set as a given, the field of capital budgeting relies on the work of people in the areas of industrial engineering, research and development, and management information systems (among others) for the creation of investment opportunities. As such, it is important to suggest that students keep in mind the importance of creativity in this area, as well as the importance of analytical techniques. Because a project is financially sound, it must be ethically sound, right? Well . . . the question of ethical appropriateness is less frequently discussed in the context of capital budgeting than that of financial appropriateness. Consider the following simple example: The American Association of Colleges and Universities estimates that 10 percent of all college students cheat at some time during their postsecondary education careers. You might pose the ethical question of whether it would be proper for a publishing company to offer a new book How to Cheat: A User's Guide. The company has a cost of capital of 8% and estimates it could sell 10,000 volumes by the end of year one and 5,000 volumes in each of the following two years. The immediate printing costs for the 20,000 volumes would be $20,000. The...

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...CHAPTER ONE Introduction Understanding and being able to use capital budgeting techniques and investment appraisal tools is usually a standard requirement for most business degrees. In addition learning such methods will also give one an advantage in a real business situation, in which there is the consideration of significant capital expenditure project. Capital budgeting assists management decisions making on the process of ensuring growth of the organization. The techniques are divided into two types: one, Traditional (non-discounting) that includes pay back method, accounting rate of return (ARR). Two, discounting cash flow that includes net present value (NPV), internal rate of return (IRR) Profitability Index (PI). Before an investment appraisal is conducted, there are a number of points to keep in mind. Whilst the tool presented will give an evaluation of the worth of a project, one should consider that the answer is only a guide. In short, the results of an investment appraisal should be considered in conjunction with both common sense and other qualitative factors such as a business’s overall strategy. Secondly, before an investment appraisal is conducted, one should consider whether or not the project is mutually exclusive. Where a project is mutually exclusive, then only the best project should be selected. Where on the other hand, projects are independent; one may select all projects which give the appropriate return. 1.1 Background of the study Corporate......

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...QRB 501 WEEK 6 CAPITAL BUDGETING CASE A+ Graded Tutorial Available At: http://hwsoloutions.com/?product=qrb-501-week-6-capital-budgeting-case Visit Our website: http://hwsoloutions.com/ Product Description QRB 501 Week 6 Capital Budgeting Case, QRB 501 Week 6 Capital Budgeting Case Capital Budgeting Case Five executives at Team A Entertainment would like to expand the company by acquiring another company within a different market. The company has $250,000.00 to spend on the acquisition and the executives have narrowed it down to two corporations. After analyzing the final two corporations in more details the executives must recommend to the board of directors which of the two corporations the company should acquire and outline the details that helped reach this conclusion. Projected Income Statements Corporation A shows an increase in revenues over the next five years of 10 percent, and within the same time frame the company expenses will increase by 15 percent. The below income statement shows that Corporation A will maintain a positive net income year over year with a percent change of 41.2 percent from 2014 to 2018. Corporation A Projected Income Statement For Years Ending December 31, 2014 through December 31, 2018 Projected 2014 Projected 2015 Projected 2016 Projected 2017 Projected 2018 Revenue $ 110,000 $ 121,000 $ 133,100 $ 146,410 $ 161,051 Operating Expenses Operating Expense 23,000 26,450 30,418 34,980 40,227 Depreciation Expense 5,000 5,000......

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...501 WEEK 6 CAPITAL BUDGETING CASE To purchase this, Click here http://www.activitymode.com/product/qrb-501-week-6-capital-budgeting-case/ Contact us at: SUPPORT@ACTIVITYMODE.COM QRB 501 WEEK 6 CAPITAL BUDGETING CASE QRB 501 Week 6 Learning Team Capital Budgeting Case Study Complete the Capital Budgeting Case. The assignment instructions are available in the University of Phoenix Material: Capital Budgeting Case. Activity Mode aims to provide quality study notes and tutorials to the students of QRB 501 Week 6 Capital Budgeting Case in order to ace their studies. QRB 501 WEEK 6 CAPITAL BUDGETING CASE To purchase this, Click here http://www.activitymode.com/product/qrb-501-week-6-capital-budgeting-case/ Contact us at: SUPPORT@ACTIVITYMODE.COM QRB 501 WEEK 6 CAPITAL BUDGETING CASE QRB 501 Week 6 Learning Team Capital Budgeting Case Study Complete the Capital Budgeting Case. The assignment instructions are available in the University of Phoenix Material: Capital Budgeting Case. Activity Mode aims to provide quality study notes and tutorials to the students of QRB 501 Week 6 Capital Budgeting Case in order to ace their studies. QRB 501 WEEK 6 CAPITAL BUDGETING CASE To purchase this, Click here http://www.activitymode.com/product/qrb-501-week-6-capital-budgeting-case/ Contact us at: SUPPORT@ACTIVITYMODE.COM QRB 501 WEEK 6 CAPITAL BUDGETING CASE QRB 501 Week 6 Learning Team Capital Budgeting Case Study Complete the Capital Budgeting Case. The......

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...Team B Capital Budgeting Case Study Karissa Hall, M. Paul Mitchell & Augustine Flores QRB 501 November 9, 2015 Dorrell Crittenden Team B Capital Budgeting Case Study INTRODUCTION A Capital budget is defined as, the process of decision making with respect to investments made in fixed assets—that is, allowing for one to determine what course of action to take especially as concern whether a proposed project should be accepted or rejected or whether an investment should be made (Keown, Martin, & Petty, 2014). Team B’s goal this week was to define, analyze, and interpret a Capital Budgeting Case, that included, (a) a five-year projected income statement, (b) a five-year projected cash flow, (c) Net present value (NPV), and (d) Internal rate of return (IRR). The team has attached a spreadsheet detailing the analysis done for each corporation as well as offering a recommendations of which of the two corporation should be acquired. RATIONALE BEHIND NET PRESENT VALUE (NPV): Net present value ************* ****************** ***************** ******* *************** ************** ************* *********** ************** ******** ********** ************ ************ ************ ************* ********** ****** ********* *************** ************** ************* ******* ******* ********** ************** ****** ********** ************ ************ ****** ******* ******* ************* ********** ************* ************* ********** ******** ******** *******......

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...QRB 501 WEEK 6 CAPITAL BUDGETING CASE To purchase this tutorial visit here: http://wiseamerican.us/product/qrb-501-week-6-capital-budgeting-case/ contact us at: SUPPORT@WISEAMERICAN.US QRB 501 WEEK 6 CAPITAL BUDGETING CASE QRB 501 Week 6 Learning Team Capital Budgeting Case Study Complete the Capital Budgeting Case. The assignment instructions are available in the University of Phoenix Material: Capital Budgeting Case. QRB 501 WEEK 6 CAPITAL BUDGETING CASE QRB 501 Week 6 Learning Team Capital Budgeting Case Study Complete the Capital Budgeting Case. The assignment instructions are available in the University of Phoenix Material: Capital Budgeting Case. QRB 501 WEEK 6 CAPITAL BUDGETING CASE QRB 501 Week 6 Learning Team Capital Budgeting Case Study Complete the Capital Budgeting Case. The assignment instructions are available in the University of Phoenix Material: Capital Budgeting Case. QRB 501 WEEK 6 CAPITAL BUDGETING CASE QRB 501 Week 6 Learning Team Capital Budgeting Case Study Complete the Capital Budgeting Case. The assignment instructions are available in the University of Phoenix Material: Capital Budgeting Case. QRB 501 WEEK 6 CAPITAL BUDGETING CASE QRB 501 Week 6 Learning Team Capital Budgeting Case Study Complete the Capital Budgeting Case. The assignment instructions are available in the University of Phoenix Material: Capital Budgeting Case. QRB 501 WEEK 6 CAPITAL BUDGETING CASE QRB 501 Week 6 Learning Team Capital Budgeting Case......

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...CFEA3230 Advanced Managerial Finance individual assignment: MINI CASE - McKENZIE CORPORATION'S CAPITAL BUDGETING Prepared by :- RUBBIATUN ARDAWIYAH bt ABDUL HAMID CEA 080147 Prepared for:- Profesor Madya Dr. Rubi Binti Ahmad Date of submission :- 25 april 2012 MINI CASE - McKENZIE CORPORATION'S CAPITAL BUDGETING Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional company. Sam is considering opening several new restaurants. Sally Thorton, the company's CFO, has been put in charge of the capital budgeting analysis. She has examined the potential for the company's expansion and determined that the success of the new restaurants will depend critically on the state of the economy next year and over the next few years. McKenzie currently has a bond issue outstanding with a face value of $34 million that is due in one year. Covenants associated with this bond issue prohibit the issuance of any additional debt. This restriction means that the expansion will be entirely financed with equity, at a cost of $8.4 million. Sally has summarized her analysis in the following table, which shows the value of the company in each state of the economy next year, both with and without expansion. |Economic Growth |Probability |Without Expansion |With Expansion | |Low |0.3 |$30,000,000.00 |$33,000,000.00 ...

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...WHAT IS CAPITAL BUDGETING? Capital budgeting is a required managerial tool. One duty of a financial manager is to choose investments with satisfactory cash flows and rates of return. Therefore, a financial manager must be able to decide whether an investment is worth undertaking and be able to choose intelligently between two or more alternatives. To do this, a sound procedure to evaluate, compare, and select projects is needed. This procedure is called capital budgeting. I. CAPITAL IS A LIMITED RESOURCE In the form of either debt or equity, capital is a very limited resource. There is a limit to the volume of credit that the banking system can create in the economy. Commercial banks and other lending institutions have limited deposits from which they can lend money to individuals, corporations, and governments. In addition, the Federal Reserve System requires each bank to maintain part of its deposits as reserves. Having limited resources to lend, lending institutions are selective in extending loans to their customers. But even if a bank were to extend unlimited loans to a company, the management of that company would need to consider the impact that increasing loans would have on the overall cost of financing. In reality, any firm has limited borrowing resources that should be allocated among the best investment alternatives. One might argue that a company can issue an almost unlimited amount of common stock to raise capital. Increasing the......

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... Capital Budgeting When people hear the term capital budgeting, they usually focus on the budgeting part of the term rather than the capital portion. Actually, capital is the more important aspect in that it lets us know that we are evaluating a larger expenditure that will be capitalized -- in other words, depreciated over time. Remember, a capital expenditure can be many things -- a large copying machine, an automated assembly line, a building, or the ultimate in capital budgeting -- the acquisition of another entity. What is totally cool about capital budgeting is it allows you to analyze one or more projects so that you can intelligently and strategically make a decision as to which project you wish to acquire or piece of equipment you should procure. There are at least 6 capital budgeting tools that can be used in analyzing a capital expenditure (please note that the text mainly focuses on NPV and IRR) -- Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), Payback Period (PB), Discounted Payback Period (DPB), and Modified Internal Rate of Return (MIRR). Perhaps in a prior finance course, you might have learned how to calculate four of the above six tools -- NPV, IRR, PI, and PB. If not, then it will be new material for you! Now, crunching the numbers might seem by some to be the more crucial part -- and it is indeed very important. However, interpreting and analyzing the answers are just as important. Let's see if we can do this with...

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