Assignment

Capital Budgeting Analysis (Total: 10 Marks)

A company is considering an investment project with the following details:

Initial Investment: $100,000

Project Life: 5 years

Annual Net Cash Flows:

Year 1: $40,000

Year 2: $35,000

Year 3: $30,000

Year 4: $25,000

Year 5: $20,000

Discount Rate (Hurdle Rate): 10%

Salvage Value: $0

Depreciation: The asset is depreciated on a straight-line basis over 5 years.

Answer the following parts. In each section, show your calculations manually and explain what your computed result implies for the investment decision.

(a) Payback Period (2 Marks)

Compute the payback period by adding the annual net cash flows until the cumulative cash flow equals or exceeds the $100,000 initial investment.

Explain what your calculated payback period suggests regarding the project's risk and liquidity.

(b) Accounting Rate of Return (ARR) (2 Marks)

Compute the ARR and explain what the resulting ARR indicates about the project's profitability and how it might affect the investment decision.

(c) Net Present Value (NPV) (3 Marks)

Calculate the NPV and explain what the NPV result indicates regarding the project's value addition and overall desirability from a capital budgeting perspective.

(d) Internal Rate of Return (IRR) (3 Marks)

Using a trial-and-error method, calculate the NPV at two different discount rates (for example, at 15% and 20%). Use these calculations to interpolate an estimate for the IRR, the discount rate that makes NPV equal to zero. Explain how your estimated IRR compares to the required return (10%). Discuss what this comparison implies for whether the project should be accepted.

Instructions:

Clearly show all calculation steps for each part.

Integrate your explanation with the numerical results, discussing the practical implications of each capital budgeting measure.

Ensure that your answers reflect both your computational work and your analytical