Please set-up solution model for the following capital budget problem. Explain t

ID: 2794576 • Letter: P

Question

Please set-up solution model for the following capital budget problem. Explain the approach you plan to take and why. Then, please perform the calculations of your model and draw conclusions. Capital Budget Problem: This case continues following the new project of the WePPROMOTE Company, that you and your partner own. WePROMOTE is in the promotional materials business. The project being considered is to manufacture a very unique case for smart phones. The case is very durable, attractive and fits virtually all models of smart phone. It will also have the logo of your client, a prominent, local company and is planned to be given away at public relations events by your client. More details have emerged and your estimates are becoming more precise. The following are the new values to the data that you have been estimating up to this point: You can borrow funds from your bank at 3%. The cost to install the needed equipment will be $105,000 and this cost is incurred prior to any cash is received by the project. The gross revenues from the project will be $25,000 for year 1, then $27,000 for years 2 - 4. Year 5 will be $23,000. The expected annual cash outflows (current project costs) are estimated at being $13,000 for the first year, then $12,000 for years 2, 3, and 4. The final year costs will be $10,000. After 5 years the equipment will stop working and will be worthless. The discount rate you are assuming continues to be 6%.

Explanation / Answer

In the present case intial investment need to be done and benefits wiil be arising in the future years ,hence NPV (Net present value) method is used for Decision making to buy or not .

If present value of future cash flows is more than initial cash flow then buy the machine otherwise not buy the machine.

In order to buy the machine , company need to borrow the money from bank at 3% interest rate it is also cost it need to be paid at the end of the year,it is relevent cost for decison making .

Interest for every year =105000 X 3% =3150

Computation of future cashinflows

annual costs

(a)

Interest

(b)

Total cost

(c=a+b)

Gross revenue

(d)

Net Benefit

(e=d-c)

PV factor @ 6%

(f)

Present value of net benefits

(g=e X f)

The NPV of the machine is in -ve i.e -59409,hence it is advisable to company not to buy the machine

Year