Question 1: Capital Budgeting Task (18 marks total)

You are helping Initech with its capital budgeting decisions. The company is a producer and wholesaler of

electronic parts, has a 14% cost of capital and is subject to a 30% tax rate. There are two major proposals on

which Initech would like your advice.

1. The device part project

Initech is considering whether it should expand into production of a part for a new generation of mobile

devices. Trends suggest these devices and their parts will offer high growth in the early years of a 5-year life

cycle.

The new plant and equipment needed to produce the part will cost $800,000, which the business will

depreciate for tax purposes using a prime cost rate of 10% per annum. When the project is wound up at the

end of five years, the general purpose equipment is expected to be sold for an estimated $200,000.

Sales in the first year are expected to be $4,000,000, increasing at a high rate of 10% in the second and third

years and then falling by 15% per year for the last two years of the project as demand declines due to

competing new technologies. Consultants called in previously by Initech, who were paid $75,000 in fees,

estimated that variable costs for the project will be 50% of its revenues.

Building rental, fixed salaries and other fixed costs directly related to the project are expected to be

$1,500,000 in the first year and increase by 2% per year thereafter. The investment in net operating working

capital related to the project is expected to be 10% of the following years sales revenues. This investment

will be recovered by the end of the project. It is also thought that the project will encourage additional after

tax profits of $150,000 per year for Initechs existing part range.

2. The conveyer system

Initech needs to install a conveyer system as soon as possible because the existing system, which has no scrap

value, is beyond repair. Three different systems are being considered. The first, System A, is the same type

of system as the old one just a newer model. It will last 10 years and cost $40,000 to purchase and install.

The second, System B, will last 10 years and cost $55,000 to purchase and install. The third, System C, will

last 20 years and cost $130,000 to purchase and install. None of the systems will have any expected salvage

value but all will be replaced at the end of their lives. After examining all costs, the net cash outflows for

each system are: $13,000 per year for System A; $9,000 per year for System B; and $1,400 per year for

System C.

Requirements and marking criteria

Provide Initech with a memo that provides your recommendations on the two proposals. Your memo should

also include details of your analysis and briefly explain and justify your chosen methods and any assumptions

made. Table format for presenting figures is preferable.

Twelve marks will be allocated to analysis of the device part project and six marks to analysis of the conveyer

system. Marks for each will be awarded for demonstrated understanding of the issues through: justification

of chosen analytical techniques, correct application of those techniques, and appropriate and insightful

conclusions and recommendations.

I dont know how to start this question.

Is it that I have to find our the NPV first? and IRR? and PI?

And how I can calculate NPV?

I did with the execl file already, but I cant find out the NPV figures.

Please help me, give me some directions.

Thanks so much