Capital Budget Analysis Based on the inputs below prepare a capital budget analy

Question

Capital Budget Analysis

Based on the inputs below prepare a capital budget analysis for this Base Case using the Net Present Value, Internal Rate of Return, Profitability Index and Payback in Years determining whether the project is feasible.

Project Inputs:

WACC – the cost of capital (hurdle rate) will be the current yield of the 10 Year U.S. Treasury Note as of Tuesday July 5, 2016, plus 700 basis points (Please explain how you calculated it in details).

Project Investment Outlay, Year 0 - $400,000

Project Investment Life – 10 years

Project Depreciation - $40,000 / year

Project Salvage Value - $10,000

Working Capital Base of Annual Sales – 10%

Expected inflation rate per year, Selling Price Per Unit – 5%

Expected inflation rate per year, Manufacturing Cost per unit – 3.5%

Expected inflation rate per year, Fixed operating costs per year – 2.5%

Project Tax Rate – 30%

Units sold per year – 50,000

Selling Price per Unit, Year 1 - $35

Fixed operating costs per year excluding depreciation - $150,000

Manufacturing costs per unit, Year 1 - $25.20

Explanation / Answer

WACC – the cost of capital (hurdle rate) will be the current yield of the 10 Year U.S. Treasury Note as of Tuesday July 5, 2016, plus 700 basis points - Input taken from from following reference

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

!0 year rate of 5th July 2016 is 1.37 plus 70 point i.e. 0.07 hence cost of capital comes to 2.07, this rate is used for calculating cost of capital.

Year 0 1 2 3 4 5 6 7 8 9 10 Project investment Outlay        -4,00,000 Depreciation             -40,000             -40,000             -40,000             -40,000             -40,000             -40,000             -40,000             -40,000             -40,000             -40,000 Cost of capital               -8,280               -8,280               -8,280               -8,280               -8,280               -8,280               -8,280               -8,280               -8,280               -8,280 Salvage cost              10,000 Sales        17,50,000        18,37,500        19,29,375        20,25,844        21,27,136        22,33,493        23,45,167        24,62,426        25,85,547        27,14,824 Working cap         -1,75,000         -1,83,750         -1,92,938         -2,02,584         -2,12,714         -2,23,349         -2,34,517         -2,46,243         -2,58,555         -2,71,482 Operating cost         -1,50,000         -1,53,750         -1,57,594         -1,61,534         -1,65,572         -1,69,711         -1,73,954         -1,78,303         -1,82,760         -1,87,329 Manufacturing cost       -12,60,000       -13,04,100       -13,49,744       -13,96,985       -14,45,879       -14,96,485       -15,48,862       -16,03,072       -16,59,179       -17,17,251 Tax             -35,016             -44,286             -54,246             -64,938             -76,407             -88,700         -1,01,866         -1,15,959         -1,31,032         -1,50,145 Net Profit              81,704           1,03,334           1,26,574           1,51,523           1,78,284           2,06,967           2,37,688           2,70,570           3,05,741           3,50,337 PV              80,047           1,01,238           1,24,007           1,48,450           1,74,668           2,02,770           2,32,868           2,65,083           2,99,540           3,43,232 Profitability Index 20% 25% 31% 37% 44% 51% 58% 66% 75% 86% Net Cashflow           1,20,047           1,41,238           1,64,007           1,88,450           2,14,668           2,42,770           2,72,868           3,05,083           3,39,540           3,83,232 Total Cash flow        23,71,904 Payback Period (in Years) Project investment / total of net cashflow                   0.17

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