Capital Budgeting Exercise 2 Your company has spent $250,000 on research to deve
ID: 2743854 • Letter: C
Question
Capital Budgeting Exercise 2 Your company has spent $250,000 on research to develop a new computer game. The firm is planning to spend $1,400,000 on a machine to produce the new game. Shipping and installation costs for the new machine total $200,000 and these costs will be capitalized and depreciated together with the cost of the machine. The machine will be used for 3 years, has a $200,000 estimated resale value at the end of three years, and will be depreciated straight line over 4 years. Revenue from the new game is expected to be $1,200,000 per year, with costs of $500,000 per year. The firm has a tax rate of 35 percent, a cost of capital (discount rate) of 6 percent, and it expects net working capital (NWC) to increase by $150,000 at the beginning of the project. This investment in NWC will be wholly recouped at the end of the project. . a) Complete the table below. b) In the second table below calculate the Net Present Value (NPV) of the project. c) Calculate the Profitability Index (PI) of the project. d) Is the Internal Rate of Return (IRR) of the project greater than, equal to, or less than the cost of capital (discount rate)? e) Should your company proceed with this project? Explain based on the decision criteria for NPV, PI, and IRR. Year 0 1 2 3 Revenue Costs Depreciation EBIT Taxes Net Income Operating Cash Flow Change in Net Operating Working Capital Change in Gross Fixed Assets Total Free Cash Flow Net Present Value Profitability Index Internal Rate of Return >, =, or < the cost of capital (discount rate)? Proceed with the project? Explain.
Explanation / Answer
Answer 1
NPV => -1750000 + 56105 +529550 +852600 => -1750000 + 1943235
NPV => $193235
Answer 2
Profitability index => 1943235 / 1750000 => 1.11 times
Answer 3
IRR => 5.03.%
Irr is less than discouting rate.
Answer 4
Yes, we should accept the project because NPV is positive and as well as profitabilty index is greater than 1 , so it is better and profitable to accept the project.
Year 0 1 2 3 Revenue 1200000 1200000 1200000 Less :Costs 500000 500000 500000 Less: Deprecaition 400000 400000 400000 EBIT 300000 300000 300000 Tax 105000 105000 105000 Net Income 195000 195000 195000 Operating Cash Flow 595000 595000 595000 Change in Net Operating Working Capital (150000) 150000 Change in Gross FixedAssets (1600000) 270000 Total Free Cash Flow (1750000) 595000 595000 1015000 Discounting Factor 1 0.943 0.890 0.840 Present Value (1750000) 561085 529550 852600Related Questions
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