Operations Management Week 1 Discussion Questions Essay

586 Words Jun 2nd, 2015 3 Pages
8FINA 301 Capital Budgeting Exercises
Nicholas Bush
Capital Budgeting Exercise 1
You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $1500 initially, and then $400 per year in maintenance costs. Machine B costs $2000 initially, has a life of three years, and requires $300 in annual maintenance costs. Either machine must be replaced at the end of its life with an equivalent machine. Which is the better machine for the firm? The discount rate is 6% and the tax rate is zero. Year | 0 | 1 | 2 | 3 | Machine A's Cash Flows | 1,500 | 400 | 400 | 400 | Machine B's
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b) In the second table below calculate the Net Present Value (NPV) of the project. c) Calculate the Profitability Index (PI) of the project. d) Is the Internal Rate of Return (IRR) of the project greater than, equal to, or less than the cost of capital (discount rate)? e) Should your company proceed with this project? Explain based on the decision criteria for NPV, PI, and IRR. Year | 0 | 1 | 2 | 3 | | | 1,200,000 | | 1,200,000 | Revenue | | | 1,200,000 | | | | 500,000 | | 500,000 | Costs | | | 500,000 | | | | 200,000 | 200,000 | 200,000 | Depreciation | | | | | | | | 500,000 | | EBIT | | 500,000 | | 500,000 | | | | | | Taxes | | 175,000 | 175,000 | 175,000 | | | | | | Net Income | | 325,000 | 325,000 | 325,000 | | | | | | Operating Cash Flow | | 850,000 | 850,000 | 850,000 | | | | | | Change in Net Operating Working Capital | -1,200,000 | 1,200,000 | 1,200,000 | 1,200,000 | | | | | | Change in Gross Fixed Assets | | 1,350,000 | 1,350,000 | 1,350,000 | | | | | | Total Free Cash Flow | | 1,050,000 | 1,050,000 | 1,050,000 | Net Present Value | -Co = 1,200.000 C= 850,000R=6%T-= 3 years | Profitability Index | 5 years to become profitable | Internal Rate of Return >, =, or < the cost of capital (discount rate)? | > 150,000 would be the cost of capital. | Proceed with the