FIN 3104 Study Guide - Final Guide: Capital Budgeting, Net Present Value

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lavenderreindeer584

10 Apr 2020

School

Virginia Tech

Department

Finance, Insurance, Business Law

Course

FIN 3104

Professor

A J Keown

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Document Summary

Capital budgeting is decision making with respect to investment in long term assets (over one year): fixed assets, strategic decisions, large initial cash ows (ex: new hotel resort, commitment for multiple years, hard to reverse. Capital budgeting is design to answer two questions: which problems to accept, what the size of your capital budget is. Payback identi es how long it takes to recoup the initial investment outlay. Accept if the payback period is less than or equal to a pre-speci ed cut-o payback. After two years, project b has ,000 left, so you have 2 years + 2,000. However, after 5 years, project b will receive ,000,000! 2. 1. 1 negative consequences of payback: ignores the time value of money, ignores cash ows after the payback period, there is no way to determine the appropriate cut-o . 2. 1. 2 positive consequences of payback: easy to understand, emphasizes liquidity.

Related Questions

Suppose that you as the chief financial officer for Kindle Memorial Hospital and you were asked by the CEO to analyze two proposed capital investments â Project X and Project Y. Each project requires a net investment outlay of $10,000, and the cost of capital for each project is 12 percent. The projectsâ expected net cash flows are as follows:

Year Project X Project Y

0 ($10,000) ($10,000)

1 6,500 3,000

2 3,000 3,000

3 3,000 3,000

4 1,000 3,000

a. Calculate each projectâs payback period, net present value (NPV) and Internal rate of return (IRR)

b. Which project (or projects) is financially acceptable? Explain your answer briefly.

DDK Industries is considering a new capital budgeting project that will last for three years. The initial investment outlay for project equipment is expected to be $110,000. The equipment will be straight-line depreciated down to zero book value over the three year period. The expected market value of the project assets is forecasted to be $50,000 when the project is liquidated at the end of the third year. Project will require $7,000 Net Working Capital investments in years 1 and 2. The project does not require any investment in fixed assets during years 1 and 3, but a $10,000 investment is projected in year 2. DDKâs cost of capital is 12% and the project does not have a distinct risk profile. DDKâs tax rate is 35%. Based on extensive research, analysts have prepared the following incremental revenues and before tax costs:

Year	0	1	2	3
Sales (Revenues)		100,000	100,000	100,000
- Cost of Goods Sold (50% of Sales)		50,000	50,000	50,000
Depreciation		36,667	36.667	36,667
EBIT		13,333	13,333	13,333
Capital Expenditures	-110,000	0	-10,000	0

Note: Additional fixed capital investments are depreciated straight line over a three-year period; the first depreciation expense is deducted at the end of the year following the investment. The 50,000 liquidation value reflects enhancements realized through capital investments in fixed assets.

The after tax project cash flow including the terminal cash flow for the project in year 3 is closest to ___________?

goldfrog557

DDK Industries is considering a new capital budgeting project that will last for three years. The initial investment outlay for project equipment is expected to be $110,000. The equipment will be straight-line depreciated down to zero book value over the three-year period. The expected market value of the project assets is forecasted to be $50,000 when the project is liquidated at the end of the third year. The project will require $7,000 Net Working Capital investments in years 1 and 2. The project does not require any investment in fixed assets during years 1 and 3, but a $10,000 investment is projected in year 2. DDKâs cost of capital is 12% and the project does not have a distinct risk profile. DDKâs tax rate is 35%. Based on extensive research, analysts have prepared the following incremental revenues and before tax costs:

Year	0	1	2	3
Sales (Revenues)		100,000	100,000	100,000
- Cost of Goods Sold (50% of Sales)		50,000	50,000	50,000
Depreciation		36,667	36.667	36,667
EBIT		13,333	13,333	13,333
Capital Expenditures	-110,000	0	-10,000	0

The NPV and IRR of the DKK Project is closest to _________ (round up your solution to the nearest integer for NPV)

A)	$14,670, 18.415

B) $4,866; 14.10%

C) $12,179, 17.38%

D) $7,712; 15.35%

E) none of the numerical choices shown is correct

scarletgrasshopper334

FIN 3104 Study Guide - Final Guide: Capital Budgeting, Net Present Value

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