Q1. Capital Budgeting Case – Part 2
Compose a memo to the board of directors that discusses the advantages and disadvantages of each project.Make a recommendation as to which project should be adopted based on your calculations in conjunction with the business context of what is the right strategic move for Aluminum Fabricating Company.
Type your memo in a Word document.
Q2. Chapter 11 – Capital Budgeting – Net Present Value and Internal Rate of Return.
Read Finkler, chapter 11,. Net present value (NPV) and internal rate of return (IRR) are discussed. These are the two primary methods for evaluating proposed investment projects. They are both based on time value of money. NPV finds the present value of the project’s projected cash inflows using a risk-adjusted interest rate. This interest rate goes by several names, of which Finkler mentions two: the “hurdle rate,” and the “required rate.” NPV is the present value of future cash flows minus the initial project cost. If NPV is positive the project is deemed acceptable because the investment yield is higher than the hurdle rate. IRR tells you exactly what the project’s yield is; IRR looks at the project’s future cash inflows and the initial cash outflow, and calculates the interest rate that would cause NPV to equal zero. Any project whose IRR exceeds the hurdle rate is deemed acceptable. So the two methods are consistent in deciding whether a project is acceptable or not: if NPV is positive, then the IRR exceeds the hurdle rate, and vice versa.
When ranking two projects in terms of desirability, NPV and IRR can give different answers. This happens if the projects differ in size. You could have a $10 million project with NPV of $2 million and an IRR of 12%, and a second project with a 25% IRR but whose size is limited to a $5,000 investment and has NPV of $2,000. In cases like this, contextual factors would have to be considered. Can the 25% project be expanded, or lead to further high yielding business? A company would probably adopt the $10 million project since it adds significant value to the company.
To get some practice use Question for Review #10. Type the cash flow figures into an Excel spreadsheet. Put -5000 in cell A1, then continue with project’s cash inflows by typing 600 in cell A2 down to 1200 in A8. Now pick any cell, say C1, and type: =IRR(A1:A8). Format the cell so you can see a few decimals (or as many as you like!). If you go out to 3 decimal places it is 5.466%. So if the hurdle rate deemed appropriate for this project was 5% we would conclude it is acceptable. Now verify that NPV using a hurdle rate of 5% is positive. In cell C2 type: =NPV(0.05,A2:A8)+A1. You get a positive figure which in theory is the dollar amount of value added by adopting this project. Now calculate NPV using a hurdle rate of 6%; in cell C3 type: =NPV(0.06,A2:A8)+A1. You get a negative amount – no surprise because we used a hurdle rate which is greater than the project’s yield. Finally, verify that using the project’s yield (IRR) for the hurdle rate results in NPV=0. In cell C4 type: =NPV(C1,A2:A8)+A1.
Submit your spreadsheet with these calculations.
Q3. Chapter 11 – Capital Budgeting – Time Value of Money
Capital budgeting is the corporate investment decision. Just as individuals must decide what financial assets to invest in (stocks, bonds, etc), companies must decide what business assets to invest in (for example: property, plant & equipment; employee training; research & development; brand name development). In both cases, investments are evaluated in terms of the risk and return (yield) trade-off.
Time value of money is used in evaluating capital budgeting projects – Finkler provides a review (114-121) using Excel spreadsheet functions. Complete the review exercise, using the Excel template “Car loan exercise.” First, find the monthly payments on a $20,000, 6%, 3-year car loan by typing in cell A1 the following formula:
Assume the loan is taken out on December 31, 2018. Row 5 in the spreadsheet is now complete for the first monthly payment. To complete the loan repayment schedule, copy and paste row 5 to create a 36 payment schedule. The loan balance at the end of the 36th payment should equal zero.
Upload your completed schedule.
Q4. Chapter 13 – Capital Budgeting, Depreciation, & Case Study Part 1
Capital expenditures add to a company’s property & equipment, which inevitably impacts depreciation, and, since depreciation is a tax deductible expense, taxes.Continue by reading Finkler chapter 13 pages 139-147.The MACRS tax depreciation discussed in Finkler appears in the case study we will use (Aluminum Fabricating Company, Table 2).Although the case is set in 1988, MACRS still exists,allowing a fast write-off of depreciable equipment for tax purposes.
Aluminum Fabricating Company has 3 pairs of capital investments to consider – we will focus on the first pair, “Production of New Parts.”
Read pages 1 & 2 of the case, then continue with the third paragraph under “Replacement of Stamping Press” on page 3 (“As Anderson started to prepare his analysis…”).Equipment needed for the new parts orders are in the 3-year class for tax purposes (Table 2, page 4).Assume zero salvage proceeds.The Excel spreadsheet template “Aluminum FabricatingPreview the document” has two tabs, one for the Tade order, and one for Wilson.Cash flows associated with the Tade order have been compiled along with calculation of net present value and internal rate of return.Note that the cash outlay for the Tade order (start-up cost plus cost of equipment) is entered in the “time zero column” meaning that this is a cash payment at the beginning of the first year of the project.Operating cash flows and taxes are assumed to occur at the end of each year.The tax amount for year 1 is positive because the project yields a deduction which creates tax savings by offsetting income in other parts of the organization.
Depreciation & amortization is added back because they are non-cash expenses (unlike materials, labor, and administrative costs which are assumed to be cash outflows).Complete the spreadsheet by opening the Wilson tab and completing similar analysis and calculations for Wilson.You should find Wilson to have net present value of $4,144 and internal rate of return equal to 24.3%.
Template 9. Present Valueâ€”Chapter 11
Template 10. Future Valueâ€”Chapter 11
Template 11. Net Present Valueâ€”Chapter 11
Template 12. Internal Rate of Returnâ€”Chapter 11
Template 13. Calculating Straight-Line and Accelerated Depreciationâ€”Chapter 13