Capital Budgeting Scenarios
Capital Budgeting Scenarios
Shannan Coleman
FIN/486
September 23, 2012
Sal Sadiq
Capital Budgeting Scenarios
Capital Budgeting: Proposal A – New Factory Proposal A is to build a new factory to decide if this would be a feasible move for the company they need to perform a net present value analysis. To do this they will only need to look at the incremental cash flows, which are as follows: 1. Initial investment of $10 million that will be the cost to build the new factory. 2. Sales of $3 million a year that will result in an increase of $150,000 in gross margin giving the company a 5% gross margin. 3. Value of salvage at the end of the life of the project of $14 million.
NPV Computation
The following table displays the NPV computation with a 10% weighted average cost of capital for this project. Year | Cash Flow | PV Factor | Present Value | 0 | (10,000,000) | 1.0000 | (10,000,000) | 1 | 150,000 | 0.9091 | 136,364 | 2 | 150,000 | 0.8264 | 123,967 | 3 | 150,000 | 0.7513 | 112,697 | 4 | 150,000 | 0.6830 | 102,452 | 5 | 150,000 | 0.6209 | 93,138 | 6 | 150,000 | 0.5645 | 84,671 | 7 | 150,000 | 0.5132 | 76,974 | 8 | 150,000 | 0.4665 | 69,976 | 9 | 150,000 | 0.4241 | 63,615 | 10 | 14,150,000 | 0.3855 | 5,455,438 | | NPV | | (3,680,709) | The above table shows that the company will have a negative net present value of $3,680,709 for this project. The results being negative shows that if the company decides to build the new factory it will result in a decrease in the wealth of the stockholders invested in the company, which violates the concept of wealth maximization.
Take in mind that this analysis was only for a 10-year period since this would be the expected economic life of a new factory.
Shannan Coleman
FIN/486
September 23, 2012
Sal Sadiq
Capital Budgeting Scenarios
Capital Budgeting: Proposal A – New Factory Proposal A is to build a new factory to decide if this would be a feasible move for the company they need to perform a net present value analysis. To do this they will only need to look at the incremental cash flows, which are as follows: 1. Initial investment of $10 million that will be the cost to build the new factory. 2. Sales of $3 million a year that will result in an increase of $150,000 in gross margin giving the company a 5% gross margin. 3. Value of salvage at the end of the life of the project of $14 million.
NPV Computation
The following table displays the NPV computation with a 10% weighted average cost of capital for this project. Year | Cash Flow | PV Factor | Present Value | 0 | (10,000,000) | 1.0000 | (10,000,000) | 1 | 150,000 | 0.9091 | 136,364 | 2 | 150,000 | 0.8264 | 123,967 | 3 | 150,000 | 0.7513 | 112,697 | 4 | 150,000 | 0.6830 | 102,452 | 5 | 150,000 | 0.6209 | 93,138 | 6 | 150,000 | 0.5645 | 84,671 | 7 | 150,000 | 0.5132 | 76,974 | 8 | 150,000 | 0.4665 | 69,976 | 9 | 150,000 | 0.4241 | 63,615 | 10 | 14,150,000 | 0.3855 | 5,455,438 | | NPV | | (3,680,709) | The above table shows that the company will have a negative net present value of $3,680,709 for this project. The results being negative shows that if the company decides to build the new factory it will result in a decrease in the wealth of the stockholders invested in the company, which violates the concept of wealth maximization.
Take in mind that this analysis was only for a 10-year period since this would be the expected economic life of a new factory.
References: Dayananda, D., Harrison, S., & Herbohn, J., Irons, R., Rowland, P. (2002). Capital Budgeting Financial appraisal of investment projects . New York, NY: Cambridge University Press.