The following data have been collected by capital budgeting analysts at Sunrise Beach, Inc., concerning an investment

Question:

The following data have been collected by capital budgeting analysts at Sunrise Beach, Inc., concerning an investment in an expansion of the company’s product line. Analysts estimate that an investment of $400,000 will be required to initiate the project at the beginning of 2010. The estimated cash returns from the new product line are summarized in the following table; assume that the returns will be received in a lump sum at the end of each year:

Amount of

Year Cash Return

2010 . . . . . . . . . . . . . . . . . . . . . . . . . $100,800

2011 . . . . . . . . . . . . . . . . . . . . . . . . . 129,600

2012 . . . . . . . . . . . . . . . . . . . . . . . . . 156,000

2013 . . . . . . . . . . . . . . . . . . . . . . . . . 115,200

The new product line will also require an investment in inventory and receivables of $64,000; this investment will become available for other purposes at the end of the project. The salvage value of machinery and equipment at the end of the product line’s life is expected to be $60,000. The cost of capital used in Sunrise Beach, Inc.’s, capital budgeting analysis is 12%.

Required:

a. Calculate the net present value of the proposed investment. Ignore income taxes and round all answers to the nearest $1.

b. Calculate the present value ratio of the investment.

c. What will the internal rate of return on this investment be relative to the cost of capital? Explain your answer.

d. Calculate the payback period of the investment.

e. Based on the quantitative analysis, would you recommend that the product line expansion project be undertaken? Explain your answer.

f. Identify some qualitative factors that you would want to have considered with respect to this project before management proceeds with the investment.

Net Present Value
What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at... Internal Rate of Return
Internal Rate of Return of IRR is a capital budgeting tool that is used to assess the viability of an investment opportunity. IRR is the true rate of return that a project is capable of generating. It is a metric that tells you about the investment... Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Capital Budgeting
Capital budgeting is a practice or method of analyzing investment decisions in capital expenditure, which is incurred at a point of time but benefits are yielded in future usually after one year or more, and incurred to obtain or improve the... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...