Acoounting Capital Budgeting Your company is thinking about acquiring another co
ID: 2376552 • Letter: A
Question
Acoounting Capital Budgeting
Your company is thinking about acquiring another corporation. You have two choices the cost of each choice is $250,000. You cannot spend more than that, so acquiring both corporations is not an option. The following are your critical data:
Corporation A
Revenues = $100,000 in year one, increasing by 10% each year
Expenses = $20,000 in year one, increasing by 15% each year
Depreciation expense = $5,000 each year
Tax rate = 25%
Discount rate = 10%
A 5-year projected income statement
A 5-year projected cash flow
Net present value (NPV)
Internal rate of return (IRR)
Based on items (a) through (d), which company would you recommend acquiring?
(e). Also, attempt to describe the relationship between NPV and IRR. (Hint. The key factor is the discount rate used.) Show with Excel if possible.
Do not worry about COmpany B. I just need to see an example from A.
Explanation / Answer
The present value of cash flows and the net present value of the proposed investment
can be calculated as follows:
Year
Cash Flow
Present Value
Interest Factor
Present Value
Cash Flow
0
($25,000)
1.0000
($25,000)
1
5,000
0.9091
4,545
2
5,000
0.8264
4,132
3
5,000
0.7513
3,757
4
5,000
0.6830
3,415
5
5,000
0.6209
3,105
6
5,000
0.5645
2,822
7 5,000 0.5132 2,566
8
5,000
0.4665
2,333
9
5,000
0.4241
2,120
10
5,000
0.3855
1,928
Cost of Capital
10.0%
Present Value of Benefits
$30,723
Present Value of Cost
$25,000
Net Present Value
$5,723
B. The cumulative cash flow of the proposed investment for each period in both
nominal and present-value terms is:
Year
Cash
Flow
Present Value
Interest Factor
Present Value
Cash Flow
Cumulative
Cash Flow
Cumulative
PV Cash Flow
0
($25,000)
1.0000
($25,000)
($25,000)
($25,000)
1
5,000
0.9091
4,545
(20,000)
(20,455)
2
5,000
0.8264
4,132
(15,000)
(16,322)
3
5,000
0.7513
3,757
(10,000)
(12,566)
4
5,000
0.6830
3,415
(5,000)
(9,151)
5
5,000
0.6209
3,105
0
(6,046)
6
5,000
0.5645
2,822
5,000
(3,224)
7
5,000
0.5132
2,566
10,000
(658)
8
5,000
0.4665
2,333
15,000
1,675
9
5,000
0.4241
2,120
20,000
3,795
10
5,000
0.3855
1,928
25,000
5,723
Payback Period
5 years
Present Value Payback Period
8.28 years (= 8 + $658/$2,333).
C. Based on the information provided in part B, it is clear that the cumulative cash flow
in nominal dollars reached $0 at the end of Year 5. This means that the nominal
payback period is 5 years.
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