Question
Tower Inc. is in its annual Capital Budgeting review process. To complete this process, Tower Inc. wants to determine its WACC (Part A below) and
Tower Inc. is in its annual Capital Budgeting review process. To complete this process, Tower Inc. wants to determine its WACC (Part A below) and then set its hurdle rate above its WACC so that new projects are reasonably certain to increase shareholder wealth. The company has searched for investment opportunities and gathered information for each of the 5 proposals listed in Part B below. After calculating the WACC, Tower Inc. has decided to use a hurdle rate of 11.50% for all proposals being considered. Management has determined that for any project to be accepted, it must first have a Payback Period of less than 5.00 years and must have a positive NPV based on the hurdle rate. Lastly, the company has decided to ration the amount of capital for new projects at a maximum of $1,000,000.
SHOW ALL WORK. Work for each calculation to receive credit.
NOTE: Investments II & III are mutually exclusive. Management has determined that these projects represent the most important investment option for the coming year. If one of these is acceptable, it will be the first project approved for the coming year (and if both are acceptable, the project with the highest NPV will be the only one of these two accepted).
II. Investment Required = $250,000.
Cash Flows = Year 1 = $40,000
2 = 50,000
3 = 50,000
4 = 50,000
5 = 50,000
6 = 85,000
7 = 85,000
III. Investment Required = $400,000.
Cash Flows = $90,000 per year for years 1-7.
IV. Investment Required = $400,000.
Cash Flows = Year 1 = $75,000
2 = 100,000
3 = 125,000
4 = 125,000
5 = 150,000
6 = 0
Also in year 6 = $25,000 in costs to shut-down the project at the end of year 6
V. Investment Required = $700,000.
Cash Flows = $175,000 per year for years 1-7.
Capital Budgeting Decision Forms for Tower, Inc.
Project # | Payback Period | NPV | Accept/Reject |
I |
|
|
|
II |
|
|
|
III |
|
|
|
IV |
|
|
|
V |
|
|
|
Part C.
Discuss Tower, Inc.s Capital Budgeting process. Address these issues: methods used to evaluate proposals, strengths of the process, weaknesses of the process, and Towers capital rationing. (Discussion should be approximately 300-500 words).
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