Capital Budgeting Process and Techniques

Contact Manufacturing Ltd is considering two alternative investment proposals. The first proposal calls for a major renovation of the companys manufacturing facility. The second involves replacing just a few obsolete pieces of equipment in the facility. The company will choose one project or the other this year, but it will not do both. The cash flows associated with each project appear below and the firm discounts project cash flows at 15%.

1. Calculate the payback period of each project and based on this criterion, indicate which project you would recommend for acceptance.

2. Calculate the net present value (NPV) of each project and based on this criterion, indicate which project you would recommend for acceptance.

3. Calculate the internal rate of return (IRR) of each project and based on this criterion, indicate which project you would recommend for acceptance.

4. Calculate the profitability index (PI) of each project and based on this criterion, indicate which project you would recommend for acceptance.

5. Overall, you should find conflicting recommendations based on the various criteria. Why is this occurring?

6. Based on this NPV profile analysis and assuming the WACC is 15%, which project would you recommended for acceptance? Why?

7. Based on this NPV profile analysis and assuming the WACC is 25%, which project is recommended? Why?

8. Discuss the important elements to consider when deciding between these two projects.

Year Renovate Replace -$2,400,000 0 -$9,000,000 1 3,000,000 2,000,000 2 3,000,000 800,000 3 4 3,000,000 3,000,000 200,000 200,000 5 5 3,000,000 200,000 Task +