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Capital budgeting decisions learning objectives 1. understand how to use excel spreadsheet a, develop pro-forma income statement using excel spreadsheet b, compute net project cashflows,

Capital budgeting decisions

learning objectives

1. understand how to use excel spreadsheet

a, develop pro-forma 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

2) new equipment cost $(200,000)

3) equipment ship & install cost $(35,000)

4) related start-up cost $ (5,000)

5) Inventory increase $25,000

6) Accounts payable increase $5,000

7) equip. salvage value before tax $15,000

8) sales for first year (1) $200,000

9) sales increase per year 5%

10) operating cost (60% of sales) $(120,000)

(as a percent of sale in year 1 ) -60%

11) depreciation (straight line)/ TR $ (60,000)

12) Marginal corporate tax rate( T) 21%

13) Cost of captial (discount rate) 10%

Income statement

Revenue

opreating cost

Depreciation

EBIT

Taxes

Net Income

Year CF0 CF1 CF2 CF3 CF4

1) opreating cash flow

2) change in NWC

3) Captial spending

Total

Project Net cash flows

NPV= ? IRR=? Payback=?

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

Q#2 would you accept the project based on payback rule if project cut-off is 3 years?

Q#3 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 scenarios (a) and (b) would you choose? why?

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