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Capital Budgeting Problems

Capital Budgeting Problems.

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Capital Budgeting Problems

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  1. Capital Budgeting Problems • 19. Calculating EAC You are evaluating two different sound mixers. The jazzmaster costs $75,000, has a three-year life, and has pretax operating costs of $10,000 per year. The Discomaster costs $100,000, has a five-year life, and has pretax operating costs of $8,000 per year. For either sound mixer, you use straight-line depreciation to zero over the project’s life and assume a salvage value of $18,000. If your tax rate is 35 percent and your discount rate is 13 percent, compute the EAC for both mixers. Which do you prefer? Why?

  2. Capital Budgeting Problems • NPVjazzmaster=-75,000+2,250 PVIFA13%,2+13,950 PVIF13%,3 =-61,578 • NPV= EACjazzmaster PVIFA13%,3 • -61,578= EACjazzmaster 2.3612 • EACjazzmaster= -26,079.42

  3. Capital Budgeting Problems • NPVdiscomaster=-100,000+1,800 PVIFA13%,4+13,500 PVIF13%,5 =-87,318.69 • NPV= EACdiscomaster PVIFA13%,5 • -87,318.69= EACdiscomaster 3.5172 • EACdiscomaster= -24,826.19 • Decision: -24,826.19>-26,079.42 choose discomaster

  4. Capital Budgeting Problems • 24. Abandonment Value We are examining a new project. We expect • to sell 2,000 units per year at $35 net cash flow apiece for the next 10 • years. In other words, the annual operating cash flow is projected to be • $35  2,000 = $70,000 per year. The relevant discount rate is 17 percent, • and the initial investment required is $345,000. • What is the base-case NPV? • After the first year, the project can be dismantled and sold for $300,000. • If expected sales are revised based on the first year’s performance, when • would it make sense to abandon the investment? In other words, at what • level of expected sales would it make sense to abandon the project? • Suppose you think it is likely that expected sales will be revised up to • 2,800 if the first year is a success and revised downward to 1,200 if the • first year is not a success. • If success and failure are equally likely, what is the NPV of the project? • Consider the possibility of abandonment in answering. • What is the value of the option to expand or abandon?

  5. Capital Budgeting Problems • a. NPV= -345,000 + 70,000 PVIFA17%,10 = -18,897.75 • b. 300,000  S 35 PVIFA17%,9 • 300,000  S 35 4.4506 • 1,925.9  S • c.

  6. Capital Budgeting Problems • 98,000 PVIFA17%,10 =456,543.16 • 42,000 PVIFA17%,10 = 195,661.20 • =292,307.69 • 0.5 456,543.16 + 0.5 292,307.69= 374,425.43 • NPV= 374,425.43-345,000=29,425.43 • d. Option Value=29,425.43-(-18,897.75)= 48,323.18

  7. Capital Budgeting Problems

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