Assignment 2—Applying Decision-Making Skills
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atoumm_m4_a2.pptx_.pptxCapital Budgeting
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Capital Budgeting
Decision on replacing a piece of equipment for a new computerized version that promotes efficiency for the upcoming year
Is it a worthwhile investment
Capital Budgeting
Existing Equipment Original Cost 60,000 Present Book Value 30,000 Annual Cash Operating Costs 145,000 Current Market Value 15,000 Market Value in Ten Years 0 Remaining useful Life 10 years
Capital Budgeting
Replacement Equipment
Cost 600,000 Annual Cash Operating Costs 50,000 Market Value in Ten Years 0 Useful Life 10 years
Capital Budgeting
Other Information
Cost of Capital 10% Payback requirement 6 years
Capital Budgeting
Comprehensive analysis using NPV, Payback Method, and IRR
To develop a recommendation on replacing the existing equipment with a new computerized version
Payback method Under payback period we compute the cash inflow and see the period in which this is received back. The table given below indicates the payback period
| Computation of Payback period | ||
| Year | Cash flow | Cumulative cash flow |
| 0 | -585000 | -585000 |
| 1 | 95000 | -490000 |
| 2 | 95000 | -395000 |
| 3 | 95000 | -300000 |
| 4 | 95000 | -205000 |
| 5 | 95000 | -110000 |
| 6 | 95000 | -15000 |
| 7 | 95000 | 80000 |
| 8 | 95000 | 175000 |
| 9 | 95000 | 270000 |
| 10 | 95000 | 365000 |
Capital Budgeting
The payback period is 6 years and 2 months. Since the payback period requirement is 6 years, this proposal may not be accepted.
Capital Budgeting
Net Present Value
Present value is the value of future cash flows at a discount on today. This is computed as given below:
Capital Budgeting
| Computation of Net present value | |
| Year | Cash flow |
| 1 | 95000 |
| 2 | 95000 |
| 3 | 95000 |
| 4 | 95000 |
| 5 | 95000 |
| 6 | 95000 |
| 7 | 95000 |
| 8 | 95000 |
| 9 | 95000 |
| 10 | 95000 |
| Present Value | $583,733.88 |
| Less: Initial investment | 585000 |
| Net present value | ($1,266.12) |
Capital Budgeting
Since the net present value of the project is negative, the project is not recommended for approval.
Capital Budgeting
Internal Rate Return
The internal rate of return is the return which project is able to deliver with its future cash flow. The future cash flow of this project gives the IRR as follows:
Capital Budgeting
| Computation of Internal rate of return | |
| Year | Cash flow |
| 0 | -585000 |
| 1 | 95000 |
| 2 | 95000 |
| 3 | 95000 |
| 4 | 95000 |
| 5 | 95000 |
| 6 | 95000 |
| 7 | 95000 |
| 8 | 95000 |
| 9 | 95000 |
| 10 | 95000 |
| IRR | 9.95% |
Capital Budgeting
Since the IRR is less than the expected rate of return, the projected is not recommended for approval.
Capital Budgeting
The summary of results
Payback period – Project not recommended
Net Present Value - Project not recommended
Internal rate of return - Project not recommended
Hence – Project is not recommended for approval
Capital Budgeting
Thank You
