Maggie's Resorts was wondering how to use capital budgeting to decide if their $7,952,000 expansion of its number of bungalows is a good investment. Management for Maggie's Resorts developed the following estimates for the expansion: Maggie's Resorts Number of additional guests per day 520 Average number of days guests will stay 16 Useful life of the expansion in years 15 Average cash spent per day by guest $260 Average variable costs per day for each guest $90 Cost of the expansion $7,952,000 Discount rate 11% Maggie's Resorts uses straight-line depreciation and expects the expansion to have a residual value of $1,051,000 at the end of its 15 year life. (Round your answers to two decimal places when needed and use rounded answers for all future calculations). 1. Compute the average annual net cash flow from the expansion. Additional Guest per day X Average cash spent by each guest per day X Number of days guests will stay = Average Annual Cash Inflow X X = Additional Guest per day X Average variable cost by each guest per day X Number of days guests will stay = Average Annual Cash Outflow X X = Average Annual Cash Inflow - Average Annual Cash Outflow = Average annual net cash inflow - = 2. Compute the average annual operating income from expansion. Average Annual net cash inflow X Operating life of Expansion = Total net cash inflows during life of expansion X = Cost - Residual Value = Total depreciation during life of expansion - = Maggie's Resorts Total net cash inflows during operation life of expansion Less: Total depreciation during operating life of expansion Total operating income during operating life Divide by: expansions operating life in years Average annual operating income from expansion 3. Compute the payback for the expansion project. Amount Invested / Exprected annual net cash inflow = Payback / =
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Maggie's Resorts
| Number of additional guests per day | 520 |
|---|---|
| Average number of days guests will stay | 16 |
| Useful life of the expansion in years | 15 |
| Average cash spent per day by guest | $260 |
| Average variable costs per day for each guest | $90 |
| Cost of the expansion | $7,952,000 |
| Discount rate | 11% |
Maggie's Resorts uses straight-line
(Round your answers to two decimal places when needed and use rounded answers for all future calculations).
1. Compute the average annual net cash flow from the expansion.
| Additional Guest per day | X | Average cash spent by each guest per day | X | Number of days guests will stay | = | Average Annual |
|---|---|---|---|---|---|---|
| X | X | = |
| Additional Guest per day | X | X | Number of days guests will stay | = | Average Annual |
|
|---|---|---|---|---|---|---|
| X | X | = |
| Average Annual Cash Inflow | - | Average Annual Cash Outflow | = | Average annual net cash inflow |
|---|---|---|---|---|
| - | = |
2. Compute the average annual operating income from expansion.
| Average Annual net cash inflow | X | Operating life of Expansion | = | Total net cash inflows during life of expansion |
|---|---|---|---|---|
| X | = |
| Cost | - | Residual Value | = | Total depreciation during life of expansion |
|---|---|---|---|---|
| - | = |
Maggie's Resorts
| Total net cash inflows during operation life of expansion | |
|---|---|
| Less: Total depreciation during operating life of expansion | |
| Total operating income during operating life | |
| Divide by: expansions operating life in years | |
| Average annual operating income from expansion |
3. Compute the payback for the expansion project.
| Amount Invested | / | Exprected annual net cash inflow | = | Payback |
|---|---|---|---|---|
| / | = |
4. Calculate the ARR.
| (Amount Invested | + | Residual Value) | / | 2 | = | Average amount invested |
|---|---|---|---|---|---|---|
| + | / | 2 | = |
| Average Annual Operating Income | / | Average Amount Invested | = | ARR (%) |
|---|---|---|---|---|
| / | = |
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