Chapter 11. The Basics of Capital Budgeting This spreadsheet model is designed to be used in conjunction with the chapter's integrated case and the related PowerPoint slide presentation. You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with products from Daimler AG, Fid, Toyota, and other automakers. Your boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm's ignition system line; it would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3-year lives because Allied is planning to introduce entirely new models after 3 years. Here are the projects' cash flows (in thousands of dollars): Year CFS CFL ($100) $10 $60 $80 ($100) $70 $50 $20 3 Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. The CFO also made subjective risk assessments of each project and he concluded that both projects have risk characteristics that are similar to the firm's average proiect. Allied's WACC is 10%. You must determine whether one or both of the projects should be accepted. PARTA (1) What is each project's NPV? 11 Case model + TGK 10% 30 (1) What is each project's NPV? 32WACC 33 34 The solution can be found using Excel's NPV function, which finds the NPV of CF, to CF, and then 35 add the value of CF, to the result. NPV = NPV = 40 If projects Land S are independent, which one would you choose? 41 If projects and S are mutualy exclusive, which one would you choose? 43 PARTB 44 (1) What is each project's IRR? 45 46 The internal rate of return (IRR) is that discount rate which forces the NPV of a project to equal 47 zero. NPV = $0 - CF, t-0 (1 + IRR) 51 The solution to this equation can be found using Excel's IRR function. IRRL= IRR = 56 If projects L and S are independent, which one would you choose? 57 If projects L and S are mutualy exclusive, which one would you choose? > > 11 Case model + co E F 58 59 PARTC 60 (1) Draw NPV profiles for Projects L and S. At what discount rate do the profiles cross? 61 NPV ($) NPV Profiles Project L Crossover rate -8.68% Projects 0% 5% 10% wacc 15% 20% 25% Projects WACC $0.00 0.00 0.00 0% 5% 10% 15% 20% $0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 25% 0.00 ear CF Difference $0 ($60) 11 Case model + 16 U BIHA #2017 - & fx C123 A B 4 85 86 87 Year CF Difference 88 $0 ($60) $10 $60 92 IRR = Crossover rate = 93 PART D 96 (1) Find the paybacks for Projects L and S. 97 98 Payback Calculations 99 Project L Years + 100 101 102 103 80 Cash Flow Cumulative Cash Flow -100 104 105 Payback L 106 107 08 Projects Years 09 +N NW 110 Cash Flow Cumulative Cash Flow -100 -100 13 Payback S 11 Case model
