Capital Budgeting Decisions 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 $25,000 11) Depreciation Use 3-yr MACRIS

6) Accounts Payable 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) Shipping and Install cost

3) Start up expenses Total Basis Cost (1+2+3)

4) Net Working Capital Total Initial Outlay

Operations:

Revenue

Operating Cost

Depreciation

EBIT

Taxes

Net Income

Add back Depreciation

Total Operating Cash Flow XXXXX XXXXX XXXXX XXXXX Terminal:

1) Change in net WC $- $- $- $20,000

2) Salvage value (after tax) Salvage Value Before Tax (1-T) XXXXX

Total XXXXX

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

NPV = IRR = Payback= Profitability Index = Discounted Payback =

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 Capital Budgeting (Investment ) Decisions (a) Estimate NPV, IRR and Payback Period of the project if equipment is fully depreciated in first year and tax rate equals to 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 CEO what NPV means?

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

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

What other info needed? this is the problem