2176 Words9 Pages

Capital Budgeting

Luz A comas

Strayer University

Professor: Michael Hamuicka

Financial Management – FIN 534

05/02/2011

Abstract

Capital budgeting is one of the most important areas of financial management. There are several techniques commonly used to evaluate capital budgeting projects namely the payback period, accounting rate of return, present value and internal rate of return and profitability index. Recent studies highlight that financial managers worldwide favor methods such as the internal rate of return (IRR) or non-discounted payback period (PP) models over the net present value (NPV), which is the model academics consider superior. The term capital budgeting refers to long term planning for*…show more content…*

Management also plans to assume that the initial capital expenditures (and therefore depreciation), additions to working capital, and continuation value remain as initially specified in the table. What is the NPV of this project under these alternative assumptions? How does the NPV change if the revenues and operating expenses grow by 5% per year rather than by 2%?

d. To examine the sensitivity of this project to the discount rate, management would like to compute the NPV for different discount rates. Create a graph, with the discount rate on the x-axis and the NPV on the y- axis, for discount rates ranging from 5% to 30%. For what ranges of discount rates does the project have a positive NPV?

Answers:

a. The NPV of the estimate free cash flow is

NPV = - 150 + 36 X 1 (1- 1/ (1.12) ^9) + 48 = $57.3 million. 0.12 (1.12) ^10

b. Initial Sales 90 100 110

NPV 20.5 57.3 94.0

Bauer Industries | Free cash flow Projections ( in millions of dollars) | | | | | | | | | | | | | | year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | Revenues | | 110 | 110 | 110 | 110 | 110 | 110 |

Luz A comas

Strayer University

Professor: Michael Hamuicka

Financial Management – FIN 534

05/02/2011

Abstract

Capital budgeting is one of the most important areas of financial management. There are several techniques commonly used to evaluate capital budgeting projects namely the payback period, accounting rate of return, present value and internal rate of return and profitability index. Recent studies highlight that financial managers worldwide favor methods such as the internal rate of return (IRR) or non-discounted payback period (PP) models over the net present value (NPV), which is the model academics consider superior. The term capital budgeting refers to long term planning for

Management also plans to assume that the initial capital expenditures (and therefore depreciation), additions to working capital, and continuation value remain as initially specified in the table. What is the NPV of this project under these alternative assumptions? How does the NPV change if the revenues and operating expenses grow by 5% per year rather than by 2%?

d. To examine the sensitivity of this project to the discount rate, management would like to compute the NPV for different discount rates. Create a graph, with the discount rate on the x-axis and the NPV on the y- axis, for discount rates ranging from 5% to 30%. For what ranges of discount rates does the project have a positive NPV?

Answers:

a. The NPV of the estimate free cash flow is

NPV = - 150 + 36 X 1 (1- 1/ (1.12) ^9) + 48 = $57.3 million. 0.12 (1.12) ^10

b. Initial Sales 90 100 110

NPV 20.5 57.3 94.0

Bauer Industries | Free cash flow Projections ( in millions of dollars) | | | | | | | | | | | | | | year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | Revenues | | 110 | 110 | 110 | 110 | 110 | 110 |

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