BBC Co Capital Budget Memo

The Board of BBC Co has decided to limit investment funds to $$10$ million for the next year and is preparing its capital budget. The company is considering five projects, as follows:

Initial investment Net present value

Project A $$2,500,000$ $$1,000,000$

Project B $$2,200,000$ $$1,550,000$

Project C $$2,600,000$ $$1,350,000$

Project D $$1,900,000$ $$1,500,000$

Project E $$5,000,000$ To be calculated.

All five projects have a project life of four years. Projects A$,$ B$,$ C$,$ and D are divisible, and Projects B and D are mutually exclusive. All net present values are in nominal, after$-$tax terms.

Project E

This is a strategically important project that the Board of BBC Co has decided must be undertaken for the company to remain competitive, regardless of its financial acceptability. Information relating to the future cash flows of this project is as follows:

Year $1234$

Sales volume $($units$)12,65012,10010,00010,000$

Selling price $($$$/$unit$)440475500570$

Variable cost $($$$/$unit$)260280295320$

Fixed costs $($$$000)750750750750$

These forecasts are before taking account of selling price inflation of $50\%$ per year, variable cost inflation of $60\%$ per year, and fixed cost inflation of $35\%$ per year. The fixed costs are incremental fixed costs which are associated with Project E$.$ At the end of four years, machinery from the project will be sold for scrap with a value of $$400,000.$

The initial investment cost of Project E is in CCA class $44(25\%$ deduction$).$ BBC applies the maximum deprecation based on the CCA class. The project will be sold at book value in the final year of operation. BBC Co pays a corporation tax of $28\%$ annually, one year in arrears.

BBC Co has a nominal after$-$tax capital cost of $13\%$ per year.

Required:

$($a$)$ Calculate the nominal after$-$tax net present value of Project E and comment on the financial acceptability of this project.

$($b$)$ Calculate the maximum net present value obtained from investing the fund of $$10$ million, assuming that the nominal after$-$tax NPV of Project E is zero.

$($c$)$ Discuss why the Board of ABB Co may have decided to limit investment funds for the following year.