Capital Budgeting Decisions CASE STUDY

Learning Objectives

$1.$ Understand how to use EXCEL Spreadsheet

$($a$)$ Develop proforma Income Statement Using Excel Spreadsheet

$($b$)$ Compute Net Project Cashflows, NPV$,$ and IRR

$($c$)$ Develop problem$-$solving and critical thinking skills

and make long$-$term investment decisions

$1)$ Life Period of the Equipment $=4$ years $8)$ Sales for first year $(1)$ $$200,000$

$2)$ New equipment cost $($$$200,000)9)$ Sales increase per year $5\%$

$3)$ Equipment ship & install cost $($$$35,000)10)$ Operating cost $(60\%$ of Sales$)$ $$(120,000)$

$4)$ Related start up cost $($$$5,000)($as a percent of sales in Year $1)-60\%$

$5)$ Inventory increase $$25,00011)$ Depreciation Use $3-$yr MACRIS

$6)$ Accounts Payable increase $$5,00012)$ Marginal Corporate Tax Rate $($T$)35\%$

$7)$ Equip. salvage value before tax $$15,00013)$ Cost of Capital $($Discount Rate$)10\%$

Filling data in the cells colored only. Do not write in any other cell.

Do not delete any row or column

ESTIMATING Initial Outlay $($Cash Flow, CFo, T$=0)$

$-70$

CF$0$ CF$1$ CF$2$ CF$3$ CF$4$

Year $01234$

Investments:

$1)$ Equipment cost EBIT $=$ Sales $-$ Costs $-$ D

$2)$ Shipping and Install cost

$3)$ Start up expenses

Total Basis Cost $(1+2+3)$ $$-$

$4)$ Net Working Capital

Total Initial Outlay $$-$

Depreciation Calculation

Operations:

Sales Depreciation Basis: $$-$

Operating Cost negative # of years: $4$

Depreciation $$-$ $$-$ $$-$ $$-$ Macrs $3$ years

EBIT $$-$ $$-$ $$-$ $$-$

Taxes $$-$ $$-$ $$-$ $$-$ A B A$*$B

Net Income $$-$ $$-$ $$-$ $$-$ Year Basis Macrs $\%$ Depreciation

$1$ $$-$ $$0$

Add back Depreciation $$-$ $$-$ $$-$ $$-2$ $$-$ $$0$

$3$ $$-$ $$0$

Total Operating Cash Flow $$-$ $$-$ $$-$ $$-4$ $$-$ $$0$

$0\%0$

Terminal values:

$1)$ Change in net WC

$2)$ Salvage value $($after tax$)$

Total $$-$ Salvage value$*(1-$ marginal tax rate$)$ salvage value $-$ T$*($Salvage value $-$ book value$)$

Project Net Cash Flows $$-$ $$-$ $$-$ $$-$ $$-$

NPV $=$ $$0\mathrm{.}00$ IRR $=$ #NUM! Payback$=0\mathrm{.}00$ Payback Period

Profitability Index $=$ #DIV$/0!$ Discounted Payback $=0\mathrm{.}00$ Year Projected CF Cummulative CF Count

$0$ $$-$ $$-$

$1$ $$-$ $$-$

$2$ $$-$ $$-$

$3$ $$-$ $$-$

PLEASE RESPOND TO THESE QUESTIONS ON ANOTHER TAB $4$ $$-$ $$-$

Payback period $0\mathrm{.}00$ years

Q#$1$ Would you accept the project based on NPV$,$ IRR?

Would you accept the project based on Payback rule if project cut$-$off

is $3$ years?

Q#$2$ Impact of $2017$ Tax Cut Act on Net Income, Cash Flows and Discounted Payback Period

Capital Budgeting $($Investment $)$ Decisions Present Value

$($a$)$ Estimate NPV$,$ IRR and Payback Period of the project if Year, n Projected CF Discount factor Discounted CF Cummulative CF Count

tax rate equals to $21\%.$ Would you $0$ $$-1$ $$0$ $$-$

accept or reject the project? $1$ $$-$ $$0$ $$-$

$($ b$)$ As a CFO of the firm, which of the above two scenarios $(1)$ or $(2)2$ $$-$ $$0$ $$-$

would you choose? Why? $3$ $$-$ $$0$ $$-$

Q#$3$ How would you explain to your CEO what NPV means? $4$ $$-$ $$0$ $$-$

Payback period $0\mathrm{.}00$ years

Q#$4$ What are advantages and disadvantages of using only Payback method?

Q#$5$ What are advantages and disadvantages of using NPV versus IRR?

$1/(1+$r$)^$n

Q#$6$ Explain the difference between independent projects and mutually exclusive projects.

When you are confronted with Mutually Exclusive Projects and have coflicts

with NPV and IRR results, which criterion would you use $($NPV or IRR$)$ and why?

For Q$2,$

First complete this spreadsheet;

Then right$-$click on the tab

Select 'Move or Copy'

Check the 'Create a Copy' box in the lower$-$left corner of the pull$-$out menu

Click $"$OK$"$ n

a copy of the completed spreadsheet will be cre