A company is considering the following investment project:
Capital outlay $200,000
Net Profit p.a. (before depreciation and tax) $ 90,000
Depreciation p.a. $ 40,000
Economic life: 5 years
Salvage value: Zero
Tax rate payable (assume paid in year of income): 30%
Required rate of return: 12% (WACC + Risk factor)
Assessment Task: Calculate the following:
(i) The Net Profit After Tax for each year.
(ii) The Annual Cash Flow for each year.
(iii) Accounting Rate of Return (using total investment).
(iv) Payback Period.
(v) Net Present Value.
(vi) Internal Rate Of Return
Evaluating projects on an Independent Basis (rather than Mutually Exclusive) and using NPV evaluation method would mean:
Choose the individual project with the highest NPV (Net Present Value).
(ii) Choose the individual project with the highest ARR.
(iii) Choose all projects with a positive NPV.
(iv) Choose all projects with an ARR greater than the W.A.C.C.
A company is considering the following investment project:
Capital outlay $200,000
Net Profit p.a. (before depreciation and tax) $ 90,000
Depreciation p.a. $ 40,000
Economic life: 5 years
Salvage value: Zero
Tax rate payable (assume paid in year of income): 30%
Required rate of return: 12% (WACC + Risk factor)
Assessment Task: Calculate the following:
(i) The Net Profit After Tax for each year.
(ii) The Annual Cash Flow for each year.
(iii) Accounting Rate of Return (using total investment).
(iv) Payback Period.
(v) Net Present Value.
(vi) Internal Rate Of Return
Evaluating projects on an Independent Basis (rather than Mutually Exclusive) and using NPV evaluation method would mean:
Choose the individual project with the highest NPV (Net Present Value).
(ii) Choose the individual project with the highest ARR.
(iii) Choose all projects with a positive NPV.
(iv) Choose all projects with an ARR greater than the W.A.C.C.
Related questions
| 1. Understand how to use EXCEL Spreadsheet | |||||||
| (a) Develop proforma Income Statement Using ExcelSpreadsheet | |||||||
| (b) Compute Net Project Cashflows,NPV, and IRR | |||||||
| (c) Developproblem-solving and critical thinking skills | |||||||
| and make long-term investment decisions | |||||||
| 1) LifePeriod of the Equipment = 4 years | 8) Sales for first year (1) | $200,000 | |||||
| 2) Newequipment cost | $(200,000) | 9) Sales increase per year | 5% | ||||
| 3)Equipment ship & install cost | $(35,000) | 10) Operating cost (60% of Sales) | $(120,000) | ||||
| 4) Relatedstart up cost | $(5,000) | (as a percent of sales in Year 1) | -60% | ||||
| 5)Inventory increase | $25,000 | 11) Depreciation (Straight Line)/YR | $(60,000) | ||||
| 6) AccountsPayable increase | $5,000 | 12) Marginal Corporate Tax Rate (T) | 21% | ||||
| 7) Equip.salvage value before tax | $15,000 | 13) Cost of Capital (Discount Rate) | 10% | ||||
| ESTIMATING Initial Outlay (Cash Flow, CFo, T= 0) | |||||||
| CF0 | CF1 | CF2 | CF3 | CF4 | |||
| Year | 0 | 1 | 2 | 3 | 4 | ||
| Investments: | |||||||
| 1)Equipment cost | |||||||
| 2) Shippingand Install cost | |||||||
| 3) Start upexpenses | |||||||
| Total Basis Cost (1+2+3) | |||||||
| 4) Net Working Capital | |||||||
| Total Initial Outlay | |||||||
| Operations: | |||||||
| Revenue | |||||||
| OperatingCost | |||||||
| Depreciation | |||||||
| EBIT | |||||||
| Taxes | |||||||
| Net Income | |||||||
| Addback Depreciation | |||||||
| Total Operating Cash Flow | XXXXX | XXXXX | XXXXX | XXXXX | |||
| Terminal: | |||||||
| 1) Changein net WC | $- | $- | $- | $20,000 | |||
| 2) Salvagevalue (after tax) | Salvage Value Before Tax (1-T) | XXXXX | |||||
| Total | XXXXX | ||||||
| Project Net Cash Flows | $- | $- | $- | $- | $ | ||
| NPV = | IRR = | Payback= | |||||
| Q#1 | Would you accept the project based on NPV, IRR? | ||||||
| Would you accept the project based on Payback rule if projectcut-off | |||||||
| is 3years? | |||||||
| Q#2 Impact of 2017 Tax Cut Acton Net Income, Cash Flows and | |||||||
| Capital Budgeting (Investment ) Decisions | |||||||
| (a) | Estimate NPV, IRR and Payback Period of the project if equipment isfully | ||||||
| depreciated in first year and tax rate equalsto 21%. Would you | |||||||
| accept or reject the project? | |||||||
| (b) | As a CFO of the firm, which of the above two scenario(a) or (b) | ||||||
| would you choose? Why? | |||||||
| Q#3 How would you explain to your CEOwhat NPV means? | |||||||
| Q#4 What are advantages anddisadvantages of using only Payback method? | |||||||
| Q#5 What are advantages and disadvantages of usingNPV versus IRR? | |||||||
| Q#6 Explain the difference between independent projectsand mutually exclusive projects. | |||||||
| When you are confronted with Mutually Exclusive Projects and havecoflicts | |||||||
| with NPV and IRR results, which criterion would you use (NPV orIRR) and why? *****SHOW WORK PLEASE !!!! | |||||||
RozzisRozzis
Construction is analyzing its capital expenditure proposals forthe purchase of equipment in the coming year. The capital budget islimited to
$ 5 comma 000 comma 000$5,000,000
for the year.
LindaLinda
BensonBenson?,
staff analyst at
RozzisRozzis?,
is preparing an analysis of the three projects underconsideration by
ChesterChester
RozzisRozzis?,
the? company's owner.
Requirement 1. Because the? company's cash is?limited,
RozzisRozzis
thinks the payback method should be used to choose between thecapital budgeting projects.
a. What are the benefits and limitations ofusing the payback method to choose between? projects?
Benefits of the payback? method:
A.
Easy to understand and captures uncertainty about expected cashflows in later years of a project
Your answer is correct.
B.
Indicates whether or not the project will earn the? company'sminimum required rate of return
C.
Utilizes the time value of money and computes each? project'sunique rate of return
D.
All of the above
Limitations of the payback? method:
A.
Cannot be used when? management's required rate of return variesfrom one period to the next.
B.
Cannot be used for projects with unequal periodic cash flows
C.
Fails to incorporate the time value of money and does notconsider a? project's cash flows after the payback period
D.
All of the above
Data Table:
Project A
Project B
Project C
Projected cash outflow
Net initial investment
$3,000,000
$2,100,000
$3,000,000
Projected cash inflows
Year 1
$1,200,000
$1,200,000
$1,700,000
Year 2
1,200,000
600,000
1,700,000
Year 3
1,200,000
500,000
200,000
Year 4
1,200,000
100,000
Required rate of return
8%
8%
8%
Requirements:
1. | Because the? company's cash is? limited, RozzisRozzis thinks the payback method should be used to choose between thecapital budgeting projects. | |
a. | What are the benefits and limitations of using the paybackmethod to choose between? projects? | |
b. | Calculate the payback period for each of the three projects. Ignoreincome taxes. Using the payback? method, which projects should RozzisRozzis ?choose? | |
2. | BensonBenson thinks that projects should be selected based on their NPVs. Assumeall cash flows occur at the end of the year except for initialinvestment amounts. Calculate the NPV for each project. Ignoreincome taxes. | |
3. | Which? projects, if? any, would you recommend? funding? Brieflyexplain why. | |
