Question A Capital Budgeting (15 marks)

The capital budgeting analysis was completed by a company Chief Financial Officer (CFO) for the following project. Answer the questions below.

Questions - Calculate or answer the following:

1. The profitability index for the project?

2. The return on sales for each year (ROS). Calculate the average return on sales for the five years. The ROS statistic is used for which type of responsibility centre?

3. The company set goals for the accounting average return of 20%, payback period of 5 years, return on sales of 10% and required investment return of 10%. Would you accept or reject the project and why?

Yr. O Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5 Cumulative Income Statement: Sales Cost of Goods Sold Gross Profit Fixed Expenses (excluded Depreciation) Depreciation Earnings Before Interest and Taxes (EBIT) Taxes Net Income 550,000 (165,000) 385,000 (165,000) (100,000) 120,000 (30,000) 90,000 516,670 (155,001) 361,669 (155,001) (100,000) 106,668 (26,668) 80,000 350,000 (105,000) 245,000 (105,000) (100,000) 40,000 (10,000) 30,000 300,000 (90,000) 210,000 (90,000) (100,000) 20,000 (5,000) 15,000 250,000 (75,000) 175,000 (75,000) (100,000) 286,668 215,000 Cash Flows: EBIT Add Depreciation Subtract Taxes Operating Cash Flows 100,000 120,000 100,000 (30,000) 190,000 106,668 100,000 (26,668) 180,000 40,000 100,000 (10,000) 130,000 20,000 100,000 (5,000) 115,000 100,000 Assets Purchases: Proposed Investment in Equipment Investment in Inventories Residual Value of Equipment after Tax Total Cash Flows (500,000) (20,000) 20,000 50,000 170,000 (520,000) 190,000 180,000 130,000 115,000 0.909 Discount Factor at 10% Present Values 1.000 1520 000 0.826 14R 68 0.751 97620 0.683 78 545 0.621 105 570 172 710