Big Bang Ltd is considering to invest in one of the two following projects to buy a new equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 8%. The cash flows of the projects are provided below. Equipment 1Equipment 2Cost$186,000$195,000Future Cash FlowsYear 1Year 2Year 3Year 4Year 5 86 00093 00083 00075 00055 000 97 00084 00086 00075 00063 000Big Bang’s net income in current year is $450,000. The company maintains a capital structure of 55% in equity funding and 45% in debt funding. Required:Identify which option of equipment should the company accept based on NPV method (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification)Identify which option of equipment should the company accept based on Profitability Index method.Which equipment option should the company finally choose if the company is facing soft capital rationing?How much dividend Big Bang Ltd can pay its shareholders given the chosen project you decided in question (3) and if the Residual Dividend Payout Policy applies?

Net Present Value: It is the difference between the cash outflows and cash inflows discounted over…

Answered: Identify which option of equipment…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter10: Capital Budgeting: Decision Criteria And Real Option

Section: Chapter Questions

Problem 12P

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Question

Big Bang Ltd is considering to invest in one of the two following projects to buy a new equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 8%. The cash flows of the projects are provided below.

Equipment 1

Equipment 2

Cost

$186,000

$195,000

Future Cash Flows

Year 1

Year 2

Year 3

Year 4

Year 5

86 000

93 000

83 000

75 000

55 000

97 000

84 000

86 000

75 000

63 000

Big Bang’s net income in current year is $450,000. The company maintains a capital structure of 55% in equity funding and 45% in debt funding.

Required:

Identify which option of equipment should the company accept based on NPV method (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification)
Identify which option of equipment should the company accept based on Profitability Index method.
Which equipment option should the company finally choose if the company is facing soft capital rationing?
How much dividend Big Bang Ltd can pay its shareholders given the chosen project you decided in question (3) and if the Residual Dividend Payout Policy applies?

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