Capital Budgeting Exercise 2 Your company has spent $250,000 on research to develop a new computer game. The firm is planning to spend $1,400,000 on a machine to produce the new game. Shipping and installation costs for the new machine total $200,000 and these costs will be capitalized and depreciated together with the cost of the machine. The machine will be used for 3 years, has a $200,000 estimated resale value at the end of three years, and will be depreciated straight line over 4 years. Revenue from the new game is expected to be $1,200,000 per year, with costs of $500,000 per year. The firm has a tax rate of 35 percent, a cost of capital (discount rate) of 6 percent, and it expects net working capital (NWC) to increase by $150,000 at the beginning of the project. This investment in NWC will be wholly recouped at the end of the project. . a) Complete the table below. b) In the second table below calculate the Net Present Value (NPV) of the project. c) Calculate the Profitability Index (PI) of the project. d) Is the Internal Rate of Return (IRR) of the project greater than, equal to, or less than the cost of capital (discount rate)? e) Should your company proceed with this project? Explain based on the decision criteria for NPV, PI, and IRR. Year 0 1 2 3 Revenue Costs Depreciation EBIT Taxes Net Income Operating Cash Flow Change in Net Operating Working Capital Change in Gross Fixed Assets Total Free Cash Flow Net Present Value Profitability Index Internal Rate of Return >, =, or < the cost of capital (discount rate)? Proceed with the project? Explain. Complete the table below. In the second table below calculate the Net Present Value (NPV) of the project. Calculate the Profitability Index (PI) of the project. Is the Internal Rate of Return (IRR) of the project greater than, equal to, or less than the cost of capital (discount rate)? Should your company proceed with this project? Explain based on the decision criteria for NPV, PI, and IRR.

Complete the table below.

In the second table below calculate the Net Present Value (NPV) of the project.

Calculate the Profitability Index (PI) of the project.

Is the Internal Rate of Return (IRR) of the project greater than, equal to, or less than the cost of capital (discount rate)?

Should your company proceed with this project? Explain based on the decision criteria for NPV, PI, and IRR.

Year	0	1	2	3
Revenue		1,200,000	1,200,000	1,200,000
Costs		500,000	500,000	500,000
Depreciation		400,000	400,000	400,000
EBIT		300,000	300,000	300,000
Taxes		105,000	105,000	105,000
Net Income		195,000	195,000	195,000
Operating Cash Flow		595,000	595,000	595,000
Change in Net Operating Working Capital	-150,000			150,000
Change in Gross Fixed Assets	-1,600,000			270,000
Total Free Cash Flow	-1,750,000	595,000	595,000	1,015,000

Net Present Value	-1,750,000 + 561,085 + 529,550 + 852,600 => -1,750,000 + 1,943,235 NPV = 193,235
Profitability Index	1,943,235 / 1,750,000 = 1.11 times
Internal Rate of Return >, =, or < the cost of capital (discount rate)?	IRR => 5.03% 5.03% is less than the discounted rate of 6%.
Proceed with the project? Explain.	The project should be accepted because the NPV (Net Preset Value) is positive.