Capital Budgeting - Lite orange juice Project

3. Estimate the project’s NPV. Would you recommend that Tucker Hansson proceed with the investment?

5. If debt is used to finance this project, should the interest payments associated with this new debt be considered cash flows?

1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow.

We focus on free cash flows rather than accounting profits because these are the flows that the firm receives and can reinvest. Only by examining cash flows are we able to correctly analyze the timing of the benefit or cost. Also, we are only interested in these cash flows on an after tax basis as only those flows are available to the shareholder. In addition, it is only the incremental cash flows that interest us, because, looking at the project from the point of the company as a whole, the incremental cash flows are the marginal benefits from the project and, as such, are the increased value to the firm from accepting the project.

See Table 1: Expected non-operating cash flow when the project is terminated at year 4 = 165,880$

2. Use the projections provided in the case to compute the incremental cash flows for the PCB project. Provide a reasonable estimate for cash flows after 2009 as well.

Estimate the project’s operating cash flows for each year of the project’s economic life. (Hint: Use Table 2 as a guide)

The analysis of the financial projection in this report is based on the assumptions and the information which you (client) provided. These assumptions and information can be change with the passage of time. The

Answer: When determining the incremental cash flows related to the project, we should not include interest expense, even if the project will be partly financed by debt. We will take the interest cost into consideration when we perform the net present value analysis on these cash flows. At that point, the required rate of return we will use will be a rate that will take into consideration the cost of both debt and equity financing, and therefore, the effect of interest costs (and the effect of the cost of equity) will be considered at that time. Usually, the WACC will be used as the required rate of return, as long as the project is an average-risk project for the company.

Project cash flows – Evaluations of revenues, expenses, resulting cash flow, and the changes in revenues and expenses with the fulfilment of the acquisition of the capital request must be calculated and confirmed by management and the budget committee (Nowicki, 2015).

A project has initial costs of $3,000 and subsequent cash inflows in years 1 – 4 of

5. The cannibalization of the profits of regular cranapple sales must be included in the analysis. This an example of a negative within-firm externality and it gets charged as an expense because it is technically lost cash flows. Management of Cranfield would have to use careful thinking and good judgement when analyzing this negative externality. If they choose not to make the lite product because of the cannibalization, then it opens the door for another firm to create the product and steal sales. The textbook sites IBM’s decision in the 1970’s to shift away from the PC business over fears of it hurting their mainframe business. That was obviously a huge mistake and acts as an example of why financial analysis can only take a firm so far. They must understand the industry and long run consequences of any given decision.

The valuation method for the project is forecasting the future free cash flows generated from the project and calculating its net present value (NPV). This project has a positive NPV of $936,147, and an

She (and we) will approach the problem in five steps: 1. Determine the relevant cash flows including different possible outcomes. 2. Assess the rough financial viability of the most-likely outcome. 3. Use more sophisticated capital budgeting techniques to evaluate the project. 4. Provide quantitative measures of risks the project faces. 5 Determine how these risks affect the decision to do the project. The Time-Line of a Capital Project The first step in any capital budgeting decision is to list all the relevant cash flows. This is the hardest part of the process since it depends on having a detailed understanding of the business and requires the manager to forecast what will happen with the project in the future. It is also the most important part of the process, since if the cash flows are wrong, measures of the profitability of the project will be wrong too. Many capital projects have a similar structure: An initial investment by a firm, followed by a number of periods of regular cash inflow, followed by a terminal payment that ends the project. Our methods of evaluating projects don’t depend on this structure, but it can be helpful to think of a project this way when determining cash flows in order to be sure that you don’t forget any beginning or ending payments or costs. Nancy’s project has this kind of structure. The plan is for Digital Solutions to use its own software engineers and some temporary contract workers to develop

The following paper analyzes a project from financial perspectives using the capital budgeting techniques like Net Present Value (NPV) and Internal Rate of Return (IRR).