Required:
Complete the following problem on capital budgeting. You may collaborate with your classmates. 1 (5 points). Prepare your memo in Word (one-page, single-spaced, 12-point font). The addressees are David, Susan, and Scott. Copy the memo and paste it into your spreadsheet using Word’s “Paste Special” function to preserve the formatting. Include in your recommendation the NPV, IRR, and payback of the project based on its post-tax net cash flows. Explain the meanings of each metric. 2 (5 points). Include your supporting calculations on the same tab of the spreadsheet. Use Excel’s NPV and IRR functions to compute NPV and IRR.
Supplemental Problem on Capital Budgeting
MEMO
To: ABC
CC:
From: XYZ
Date: xx.xx.xxxx
Subject: Investment Recommendations
In capital budgeting, there are some Metrics used to make the best investment decision. These Metrics are Net Present Value (NPV), internal rate of return (IRR), and payback period. NPV is a capital budgeting metric that is used to measure the profitability of the project. It can be evaluated by subtracting the NPV of the cash flows and its cash flows over a period of time. IRR is a metric used to calculate the estimated profit of the investment. It helps in estimating the time value of money. It is a discount rate that makes all the cash flows equal to zero. The payback period is another metric in capital Budgeting that helps in defining the period of time needed for the return on the project to pay back the total of the certain investment. If the payback period is equal to or less than the payback policy of the company then it’s investable.
OVERVIEW OF PROJECT PROPOSAL
In a more detailed project, the cost of a metal-cutting machine is $230,000. The expected useful life is 10 years, savings in cash operating costs is $28,750, the tax rate is 20% and the rate of return is 6.25%. The company uses the straight-line depreciation method.
NPV determines whether the investment is profitable or not as here NPV is negative i.e. $(29,246) NPV hence it shows the investment is not profitable.
IRR helps in deciding which project is investable. The more IRR is, the more profitable it is. Here its IRR is 3.46% which is very less so we can conclude that it is not going to give a handsome return on the investment. The payback period helps in finding how much time the investment will take to repay the principal value. Less payback period shows a good return on the investment. Here the payback period is 8.33 years whereas the machine’s lifetime is 10 years so it means its payback period is very long and it is not a good investment.
Calculations:
- NPV can be calculated by adding the discounted Net cash flows of 10 years. (Discounted Net cash flows per year = Net cash flows per year* discounted factor of the )
- IRR is calculated by using the Excel formula =IRR (sum of discounted net cash flows).
- The payback period can be calculated by dividing the initial investment by the cash flows per year.
CONCLUSION
I would strongly suggest not investing in this project and should look for a better investment proposal.
