Assign #6 Capital Budgeting Exercise Camus Blalack, process engineer, knew that
ID: 2417113 • Letter: A
Question
Assign #6 Capital Budgeting Exercise Camus Blalack, process engineer, knew that the acceptance of a new process design would depend on its economic feasibility. The new process design required new equipment and an infusion of working capital. The equipment would cost $300,000 and its cash operating expenses would total $60,000 per year. The equipment would last for seven years but would need a major overhaul costing $30,000 at the end of the fifth year. At the end of seven years, the equipment would be sold for $24,000. An increase in working capital totaling $30,000 would also be needed at the beginning. This would be recovered at the end of the seven years. On the benefit side, Camus estimated that the new process would save $135,000 per year in environmental costs (fines and cleanup costs avoided). The cost of capital is 10%. Ignore tax effects. Is it beneficial to implement the new design process? Initial Cost Annual savings 1. Calculate the payback method indicator Payback Method = Initial Cost / Annual savings 2. Calculate the accounting rate of return Accounting Rate of Return = (Annual savingsDepreciation) / Initial Cost Depreciation (Cost - Salvage value) Years used 3. Calculate the net present value Net Present Value 2 4 Cost Operating expenses per year Major overhaul Salvage value Working capital Savings Total per year Discount value Present Value Net Present Value CommentaryExplanation / Answer
Answer : Assign # 6
Answer 1.
Payback method = Initial cost / Annual Savings
= 300000 / 75000
Payback method = 4 years
Answer 2
Accounting Rate of Return = (Annual savings – Depreciation) / Initial Cost
= (75000 - 39428.60) / 300000
= 35571.43 / 300000
= 0.11857
Accounting Rate of Return = 11.857%
Depreciation = Cost – Salvage value / years used
= (300000 – 24000) / 7
Depreciation = $ 39428.60
Answer 3
Figures in $
Yr
Saving in environmental cost
Cash operating Expenses
Net annual Cash saving
Equipment cost & overhaul cost & salvage value
working capital
Net annual cash inflow
Disc rate : 10%
Present value
A
B
C
D
E
F
G
A+B
C+D+E
F*G
0
0
0
0
-300000
-30000
-330000
1
-330000
1
135000
-60000
75000
0
0
75000
0.9090
68181.82
2
135000
-60000
75000
0
0
75000
0.8264
61983.47
3
135000
-60000
75000
0
0
75000
0.7513
56348.61
4
135000
-60000
75000
0
0
75000
0.6830
51226.01
5
135000
-60000
75000
-30000
0
45000
0.6209
27941.46
6
135000
-60000
75000
0
0
75000
0.5644
42335.54
7
135000
-60000
75000
24000
30000
129000
0.5131
66197.4
Net present value
44214.31
Answer : Net present value is $ 44214.31
Figures in $
Yr
Saving in environmental cost
Cash operating Expenses
Net annual Cash saving
Equipment cost & overhaul cost & salvage value
working capital
Net annual cash inflow
Disc rate : 10%
Present value
A
B
C
D
E
F
G
A+B
C+D+E
F*G
0
0
0
0
-300000
-30000
-330000
1
-330000
1
135000
-60000
75000
0
0
75000
0.9090
68181.82
2
135000
-60000
75000
0
0
75000
0.8264
61983.47
3
135000
-60000
75000
0
0
75000
0.7513
56348.61
4
135000
-60000
75000
0
0
75000
0.6830
51226.01
5
135000
-60000
75000
-30000
0
45000
0.6209
27941.46
6
135000
-60000
75000
0
0
75000
0.5644
42335.54
7
135000
-60000
75000
24000
30000
129000
0.5131
66197.4
Net present value
44214.31
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