Currently, in the capital budgeting arena, each GCS division has its own method

Question

Currently, in the capital budgeting arena, each GCS division has its own method of calculating the cost of capital resulting in different hurdle rates; thus, it leads to non-uniformity with regard to accept/reject decisions on capital investments. GCS feels that in order to maximize shareholder value, it has to come up with company-wide guidelines for calculating its cost of capital and standardize the hurdle rates and accept/reject decisions throughout the company. For the year N+6, GCS is considering the following capital budgeting projects with these projects spread around the globe: Table 6: GCS’s N+6 New Projects Under Consideration Project Net Investment Cost (US$, in millions) Proposed Location Estimated IRR Type of Project 1 $500 Europe 26.3% Existing product, new market 2 $400 USA 13.5% New product, new market 3 $650 Asia 8.6% Expand existing product in existing market 4 $1,500 Asia 23.4% New product, existing market 5 $350 USA 24.6% Replace Equipment 6 $750 Europe 10.2% Expand existing product in existing market 7 $250 Asia 26.7% Existing product, new market 8 $325 Asia 18.8% New product, existing market This table provides details of new projects under consideration by GCS in year N+6 Further, GCS has a total budget allocation (capital constraint) of US$4.2 billion for the N+6 capital investment budget. Project risk tends to vary with project type, as described in table 7

You must decide which investment project to recommend to the CFO of GCS, Gordon Brown. In order to make an informed decision, you must take financial risk and capital constraint into account.

Explanation / Answer

Inflow Project Net Investment Cost GCS US$4.2 Billion -$4,200,000,000 Project GCS’s N+6 New Projects Under Consideration Project Net Investment Cost (US$, in millions) IRR NPV      -Cash outflow +inflow Europe $500,000,000 26.30% $395,882,819 -$3,804,117,181 USA $400,000,000 13.50% $352,422,907 -$3,847,577,093 ASIA $650,000,000 8.60% $598,526,703 -$3,601,473,297 Expand existing product in existing market Europe $750,000,000 10.20% $680,580,762 -$3,519,419,238 USA $350,000,000 24.60% $280,898,876 -$3,919,101,124 ASIA Market 6 $1,500,000,000 23.40% $1,215,559,157 -$2,984,440,843 ASIA Market 7 $250,000,000 26.70% $197,316,496 -$4,002,683,504 ASIA Market 8 $325,000,000 18.80% $273,569,024 -$3,926,430,976 By comparing all above project, the investment of asia market 6 is recommended to CFO as it lower IRR in relation to cashinflow i.e. $15000000000

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.