Capital Budget Appraisal.

1
Capital Budgeting Projects Appraisal Report
ABC Healthcare Corporation
Name
Course
Professor
University

2
Capital Budgeting Projects Appraisal
ABC Healthcare Corporation
Introduction
To achieve its strategic goals, ABC Healthcare Corporation should always strive for
growth and progress. Currently, ABC is evaluating three projects that can help scaling up the
organization: major equipment purchase, expansion to three additional states, and new
marketing campaign. These three projects are independent, and so ABC can choose to
execute all of the three, a combination of two, only one project, or drop all project. By using
capital budgeting tools, ABC can evaluate the potential return of the three projects and decide
which project that has the greatest benefit in term of increasing shareholders’ value.
This report will examine the capital budgeting tools that are utilized to evaluate each
project, which include net present value analysis (NPV), internal rate of return (IRR),
payback period, and profitability index (PI). Applying this tools to the preliminary forecasted
cash flows data, we can determine how each project will provide value that will increase the
organization’s wealth. The report will provide thorough analysis about the three projects and
provide recommendation on which project that will yield the best result in term of
maximizing shareholder’s value.
Capital Budgeting Tools
Net Present Value (NPV)
The time value of money posits that the value of one dollar in hand today is worth
more than one dollar to be received in the future, as one dollar now could be invested, the
holder can earn interest, and receive more than a dollar in the future (Brigham & Houston,
2019). Time also matter in determining value of money because of risk that is related to
uncertainty of the future and inflation that will decrease the value of money in the future
(Atrill, 2019). The Net Present Value (NPV) technique allows us to calculate the present
value of future cash flows.
With discount rate d, the future value (FV) of some amount of money today (PV) will
be 𝐹𝑉 = 𝑃𝑉(1 + 𝑖)𝑡
in t years, assuming that all of the money will be reinvested. By
overturning this formula, we can get the present value of some amount of money in the future
as follows:
𝑃𝑉 =
𝐹𝑉
(1 + 𝑑)𝑡
𝑃𝑉 = Present value
FV = Future cash flow
d = Discount rate
t = Year
Formula 1 Present value calculation from future expected cash flows
The financial team has developed a forecasted future cash flows for each project. All
of the future cash flows will be converted into present value. The sum of the present values is
called net present value or NPV. The common decision rules for NPV is that a project with
positive NPV should be accepted, and a project with negative NPV should be rejected.
Further, for multiple competing projects with positive NPVs, choose the project with higher
NPV (Atrill, 2019).
The decision rules are based on the notion that, essentially, a project’s NPV is a
measure of how much wealth will be obtained by investing in the project (Higgins et al.,
2022). The higher NPV of a project, the more wealth will be generated by it. Hence, we will

3
use this NPV technique to evaluate all of the three projects’ forecasted future cash flows and
calculate the net present value (NPV) of each project.
Internal Rate of Return (IRR)
The NPV method require a fixed discount rate that usually depicts the minimum rate
of return for a company, called the cost of capital. The Internal Rate of Return (IRR) method
reversed the logic. The method calculates the discount rate that will provide zero NPV. It is
equivalent with calculating the discount rate that will make the present value of all future
cash inflows to be equal the outflows (Brigham & Houston, 2019). Since we are looking for a
positive NPV, the decision rules is to choose for the project which the IRR is higher than the
cost of capital. In most cases, if a project have positive IRR, it will also have positive NPV,
and vice versa (Higgins et al., 2022)
Calculating IRR may not as straightforward as the NPV. Iteration with trial and error
can be used but it may be more time consuming. Fortunately, there are computer softwares
that can calculate IRR with ease, such as Ms Excel. For the three projects in this report, we
will use Ms Excel calculation to obtain IRR for each project.
Payback Period
Payback period refers to the time required for a project’s cash flow to cover all the
investment costs. Project with shorter payback period is the better. Historically, this used to
be the first selection criterion to choose the best investment proposals (Brigham & Houston,
2019). However, it has three major flaws. First, it ignores time value of money, which means
all future cash flows will have the same weight. Second, it ignores the cash flows that occur
after payback regardless of how big the flows. Third, it does not tell how much value will be
added to the company (Brigham & Houston, 2019).
Nevertheless, payback period is still relevant as it provides important information. It
can better describe the projects liquidity and risk (Brigham & Houston, 2019). Cash flows
that is forecasted further in the future are considered riskier than nearer forecasted cash flows.
The faster a project’s payback period, the greater the projects liquidity. Thus, we will
calculate the payback period for each of the three projects and make a comparation.
Profitability Index (PI)
Profitability Index (PI) refers to the ratio between the present value of the future
expected cash flows and the initial investment (Ross et al., 2021). Further, the ratio can be
generalized to the proportion of all future expected cash inflows and all of the outflows
(Higgins et al., 2022). Using this definition, the formula for profitability index is as follows:
𝑃𝐼 =
𝑃𝑉(cash inflows)
𝑃𝑉(cash outflows)
A project will be profitable if the present value of the inflows is greater than the
outflows, which will result in PI greater than 1. Thus, the decision rule for PI in project
appraisal is to choose projects that have PI greater than 1 and reject the projects with PI less
than 1. Moreover, if the company must choose between multiple projects with positive PI, go
with the project has greater PI. Using this decision rules, we will evaluate the three proposals
and determine which project has the greatest PI.

4
Investment Appraisal
We will use the four capital budgeting tools above to evaluate three investment
proposals. Firstly, we should determine the relevant expected cash flows from each proposal
by analyzing the necessary incremental inflows and outflows. It is important to include only
relevant cash flows that directly relate to the project. Next, we will use Ms Excel to calculate
each of the four tools above. Then, the result will be analyzed on the next section to
determine which proposals provide the best outcome.
Investment A: Major Equipment Purchase
In investment A, ABC will purchase an expensive equipment that will significantly
improve the efficiency of the operation. The equipment will cost $10 million dollars and it
has to be incurred immediately. However, the purchase will be recorded as a 7 year MACRS
in the financial statements. Even though depreciation expense is not a cash outflow, it has a
direct effect on the income statement (Merritt, 2019). Hence, it reduces taxable income. So, it
should be included in the calculation that will determine the tax, but it should be added back
to the calculation as depreciation expense is not a cash flow (van Dalsem, 2017).
Prior to this project, the cost of sales is 60% of the revenue on average. The increase
in efficiency will reduce this cost of sales by 5% per year for 8 years, so in year 1 the cost of
sales will be 55% of the revenue, in year 2, it will be 50% of the revenue and so on. In this
case, 8 years will be the effective lifetime of the project. The annual sales will be assumed as
$20 million per year and stay the same for the lifetime period. After the lifetime is over, the
equipment is projected to be sold for about $500,000.
The project is considered a relatively safe investment, and so the financial team
considered the appropriate required rate of return of the project is 8%. The tax rate will be
presumed to be 25%. Using these information, the expected cash flows for this project can be
shown on the table on the Appendix 1. To better explain the calculation, we will provide a cut
view of the Appendix 1 as follows.
Table 1 Expected Cash Flows for Investment A (cut view)
Purchasing cost of the equipment in line (1) must be incurred immediately in year 0.
However, the depreciation expense of the equipment (5) should be included in the calculation
since it is tax deductible. The depreciation will use MACRS-7 years rate (4) as the approach.
So the line (5) is obtained by multiplying line (4) with the purchasing cost of $10 million.
Line Year 0 1 2 ... 8
(1) Purchasing Cost $10,000,000 ...
(2) Annual Sales $20,000,000 $20,000,000 ... $20,000,000
(3) Cost of the goods sold $11,000,000 $10,000,000 ... $4,000,000
(4) MACRS - 7 years rates 14.29% 24.49% ... 4.46%
(5) Annual Depreciation $1,429,000 $2,449,000 ... $446,000
(6) Earnings before interest and taxes (EBIT) / Gross Income $7,571,000 $7,551,000 ... $15,554,000
(7) Taxes (25%) / Income Taxes 1,892,750
$ 1,887,750
$ ... 3,888,500
$
(8) Earnings after taxes / Net Income $5,678,250 $5,663,250 ... $11,665,500
(9) Add Depreciation $1,429,000 $2,449,000 ... $446,000
(10) Add: After tax salvage value ... $375,000
(11) Cash Flows ($10,000,000) $7,107,250 $8,112,250 ... $12,486,500
(12) Cummulative Cash Flows ($10,000,000) ($2,892,750) $5,219,500 ... $67,875,000
(13) Present Value factor (8%) 1 0.93 0.86 ... 0.54
(14) Present value of cash flows ($10,000,000) $6,580,787 $6,954,947 ... $6,746,067
(15) Present value of cash inflows $54,262,269 ...
(16) Present value cash outflows $10,000,000 ...

5
Then, the depreciation should be added back (9) to the cash flow calculation since it is not a
cash flow.
The annual sales (2) of $20 million is fixed for 8 years, but the cost of sales (3) is
assumed to decrease 5% per year, beginning with 55% of the revenue in year 1, 50% of the
revenue in year 2, and so on. So, $11 million cost of sales in year 1 is obtained by multiplying
55% with $20 million of sales, and so on. Earnings before interest and taxes (EBIT) in line
(8) is obtained by subtracting sales (2) by the cost of sales (3) and annual depreciation (5).
Tax (7) will be calculated based on EBIT (6) by multiplying it with 25% tax rate. Net income
(8) is obtained after subtracting EBIT (6) with Tax (7). Since we involved non-cash
depreciation expense in the calculation of net income, we add it back (9) to get the overall
cash flow (11).
The expected cash flow (11) is obtained by adding (8) and (9), except for the year 0
and year 8 which includes the purchase cost (1) and after tax salvage value (10) respectively.
The salvage value is tax deductible, so the $500,000 salvage value will be deducted by 25%
to become $375,000 which is shown in line (10). These expected future cash flows will be
converted to its present value (14) using the formula 1 as present value factor.
NPV of Investment A
The NPV analysis compares the present value of a project’s cash inflows to the
present value of its cash outflows (Garrison et al., 2018). So, the NPV can be obtained by
summing all of the present value in line (14), or by substracting the present value of cash
inflows (15) by the present value of cash outflows (16). The result will show positive NPV
value of $44,262,269 which describe that the project A will increase the company’s wealth.
IRR of Investment A
The IRR of investment A can be calculated using built in Ms Excel function IRR. The
input parameter for this function is the expected cash flows (11) over the span of 8 years, not
the present value since Ms Excel will also calculate it. The result will show IRR for
investment A is 79.79% which is much higher than the 8% required rate of return.
Payback Period of Investment A
To calculate the payback period, we need to create one line for cumulative cash flows
(12). We can see that in the end of year 1 the cumulative cash flows is negative, but it is
positive at the end of year 2. So, we can tell that the payback period is between year 1 and
year 2. Assuming that the cash flows is linear according to time, we can determine the
payback period by adding the absolute proportion of cumulative cash flow (12) in year 1 and
the cash flows (11) in year 2. The result will show that the payback period of investment A is
1.36 years, which is relatively short for an investment project.
Profitability Index of Investment A
The Profitability Index can be calculated by dividing the present value of all expected
cash inflows (15) with the present value of all the expected cash outflows (16). The result
will show that profitability index for investment A is 5.43 which is higher than 1. So, the
project has a good profitability index.
Figure 1 Capital Budgeting Evaluation for Investment A
NPV Formula: $44,262,269
IRR: 79.79%
PP: 1.36
PI: 5.43

6
Investment B: Expansion to Three Additional States
In the project B, ABC will expand its operation to three additional states. This
expansion will increase the expected revenues of the company. The financial team forecasted
that due to this expansion, the revenues will be increased by 10% per year for 5 years, which
is the lifetime for this project. The cost of sales will also be increased by the same rate over
the lifetime. Prior to the project, the annual sales were $20 million.
The start-up cost for this project will be $7 million, with an additional net working
capital of $1 million that has to be provided upfront. This working capital will be regained at
the end of the project’s lifetime. Even though the $1 million is regained, this should be
included in the calculation as relevant cash flows, since according to the time value of
money, $1 million upfront will have greater value than $1 million regained 5 years later.
The project is considered a relatively somewhat risky investment, and so the financial
team considered the appropriate required rate of return of the project is 12%. The tax rate will
be presumed to be 25%. Using these information, the expected cash flows for this project can
be shown on the table on the Appendix 2. To better explain the calculation, we will provide a
cut view of the Appendix 2 as follows.
Table 2 Expected Cash Flows for Investment B (cut view)
The start-up cost of $7 million will be recorded as purchasing cost (line 1) and it is
incurred immediately. The annual sales (line 2) for year 1 is obtained by multiplying previous
year sales of $20 million with the increase rate ($20 million*110%), and for year 2, it is
obtained by multiplying annual sales in year 1 with 110%, and so on. The cost of sales (line
3) will have the same rate of increase as the annual sales. So it can be obtained by
multiplying annual sales of the particular year with 60%, or by multiplying the previous year
cost of sales with the increase rate (previous year cost of sales*110%). Both method will
provide the same value.
The annual depreciation (4) is set as straightline of $1,4 million. The EBIT (5) can be
obtained by subtracting annual sales (2) with cost of goods sold (3) and annual depreciation
(4). The EBIT value will be the basis of taxation (6) by multiplying it with the presumed tax
rate of 25%. Subtracting EBIT (5) with Tax (6), we can obtain the earnings after tax (7).
The depreciation should be added back (8) to the cash flow calculation since the
expense (4) is not a cash flow, but only included to obtain tax shield (6). After the
depreciation is added back to the earning, we obtain the cash flows (10). The net working
Line Year 0 1 2 ... 5
(1) Purchasing Cost $7,000,000
(2) Annual Sales $22,000,000 $24,200,000 ... $32,210,200
(3) Cost of goods sold $13,200,000 $14,520,000 ... $19,326,120
(4) Annual Depreciation $1,400,000 $1,400,000 ... $1,400,000
(5) Earnings before interest and taxes (EBIT) $7,400,000 $8,280,000 ... $11,484,080
(6) Tax (25%) $1,850,000 $2,070,000 ... $2,871,020
(7) Earnings after tax $5,550,000 $6,210,000 ... $8,613,060
(8) Plus Depreciation $1,400,000 $1,400,000 ... $1,400,000
(9) Net working capital $1,000,000 ... $1,000,000
(10) Cash flows ($8,000,000) $6,950,000 $7,610,000 ... $11,013,060
(11) Cummulative Cash flows ($8,000,000) ($1,050,000) $6,560,000 ... $35,043,660
(12) Present value factor (12%) 1.00 0.89 0.80 ... 0.57
(14) Present value of cash inflows $30,259,712
(15) Present Value of Cash outflows $8,000,000

7
capital (9) should be incurred immediately at year 0 but it should be added back in the end of
the year 5. This calculation is necessary to allow the time value of money determine the
difference. The expected cash flows (10) are complete after the addition in net working
capital. These expected future cash flows will be converted to its present value (13) using the
formula 1 as present value factor.
NPV of Investment B
As with the previous NPV calculation, the NPV for project B can be obtained by
summing all of the present value in line (13), or by substracting the present value of cash
inflows (14) by the present value of cash outflows (15). The result will show positive NPV
value of $22,259,712 which describe that the project B will also add value to the company.
IRR of Investment B
Again, by utilizing built in Ms Excel function for IRR, investment B’s IR can be
obtained. The input parameter for this function is the expected cash flows (10) over the span
of 5 years, not the present value since Ms Excel will also calculate it. The result will show
IRR for investment B is 91.48% which is much higher than the 12% required rate of return.
Payback Period of Investment B
The cumulative cash flows (12) are provided by adding cash flows incrementally over
the years. We can see that in the end of year 1 the cumulative cash flows is negative, but it
turns positive at the end of year 2. So, we can tell that the payback period is between year 1
and year 2. Assuming linearity of the cash flow, we can determine the payback period by
adding the absolute proportion of cumulative cash flow (11) in year 1 and the cash flows (10)
in year 2. The result will show that the payback period of investment B is 1.14 years, which is
also a short period for an investment project.
Profitability Index of Investment B
The Profitability Index can be obtained by dividing the present value of all expected
shows that profitability index for investment B is 3.78 which is higher than 1. So, the project
has a good profitability index.
Figure 2 Capital Budgeting Evaluation for Investment B
Investment C: Marketing Campaign
In project C, the investment will be used to fund a major new marketing and
advertising campaign. The campaign will cost $2 million per year for the total project
lifetime of 6 years. The company forecasted that the marketing campaign will considerably
enhance revenues and cost of sales alike by 15% per year, with the last year sales at $20
million. The marketing campaign will not involve equipment purchase, and so there will be
no depreciation expense.
The risk for the project is considered relatively moderate, and so the financial team
considered the suitable required rate of return of the project is 10%. The tax rate will be
presumed to be 25%. Using these information, the expected cash flows for this project can be
IRR: 91.48%
PP: 1.14
PI: 3.78

8
shown on the table on the Appendix 3. To better explain the calculation, we will provide a cut
view of the Appendix 3 as follows.
Table 3 Expected Cash Flows for Investment C (cut view)
The annual marketing cost (1) of $2 million will be recorded from year 1 to year 6
(line 1) and it is converted into its present value (2) using the formula 1 or using built in Ms
Excel function. In this case, all of the future marketing cost is treated as investment cost that
is incurred upfront at year 0.
The annual sales (3) for year 1 is obtained by multiplying previous year sales of $20
million with the increase rate ($20 million*115%), and for year 2, it is obtained by
multiplying annual sales in year 1 with 110%, and so on. The cost of sales (3) will have the
same rate of increase as the annual sales. So it can be obtained by multiplying annual sales of
the particular year with 60%, or by multiplying the previous year cost of sales with the
increase rate (previous year cost of sales*110%). Both method will yield the same result.
The EBIT (5) can be obtained by subtracting annual sales (3) with cost of goods sold
(4). The EBIT value will be the basis of taxation (6) by multiplying it with the presumed tax
rate of 25%. Subtracting EBIT (5) with Tax (6), we can obtain the earnings after tax (7).
Adding present value marketing cost (2) into the cash flow at year 0, we obtain the full
expected cash flows (10). These expected future cash flows will be converted to its present
value (13) using the formula 1 as present value factor (9).
NPV of Investment C
The NPV can be obtained by summing all of the present value in line (10), or by
substracting the present value of cash inflows (12) by the present value of cash outflows (13).
The result will show positive NPV value of $33,470,904 which describe that the project C
will also increase the shareholders’ value.
IRR of Investment C
The IRR of investment C will be calculated using built in Ms Excel function IRR. The
input parameter for this function is the expected cash flows (8) over the span of 6 years, not
the present value since Ms Excel will also calculate it. The result will show IRR for
investment C is 90.36% which is much higher than the 10% required rate of return.
Payback Period of Investment C
To calculate the payback period, we need to create one line for cumulative cash flows
(11). We can see that in the end of year 1 the cumulative cash flows is negative, but it is
positive at the end of year 2, which signals that the payback period is between year 1 and year
Line Year 0 1 2 ... 6
(1) Marketing / Advertising cost $2,000,000 $2,000,000 ... $2,000,000
(2) Present value of Annual marketing cost $8,710,521 ...
(3) Annual sales $23,000,000 $26,450,000 ... $46,261,215
(4) Cost of the Goods sold $13,800,000 $15,870,000 ... $27,756,729
(5) Earnings before interest and taxes (EBIT) $9,200,000 $10,580,000 ... $18,504,486
(6) Taxes (25%) $2,300,000 $2,645,000 ... $4,626,122
(7) Earnings after taxes $6,900,000 $7,935,000 ... $13,878,365
(8) Cash Flows ($8,710,521) $6,900,000 $7,935,000 ... $13,878,365
(9) Present value factor (10%) 1.00 0.91 0.83 ... 0.56
(11) Cummulative Cash flows ($8,710,521) ($1,810,521) $6,124,479 ... $51,690,274
(12) Present value of cash inflows $42,181,425
(13) Present value of cash outflows $8,710,521

9
2. Assuming that the cash flows is linear, we can determine the payback period by adding the
absolute proportion of cumulative cash flow (11) in year 1 and the cash flows (8) in year 2.
The result will show that the payback period of investment C is 1.23 years.
Profitability Index of Investment C
The Profitability Index can be calculated by dividing the present value of all expected
will show that profitability index for investment A is 4.48 which is higher than 1. So, the
project has a good profitability index.
Figure 3 Capital Budgeting Evaluation for Investment C
Analysis and Recommendation
Based on the calculation above, the three projects yield positive NPVs, high IRRs that
are greater than required rate of return for each project, relatively short payback periods, and
profitability indexes that are much greater than 1. It means that all of the projects will bring
additional shareholders’ value and increase their wealth, with relatively lower risk due to
short break-even point. Since these projects are independent, the company can choose to
execute all three if it has the resources to do so.
However, if the company has limited resources, then we can rank the projects based
on which project that will provide the best value for shareholders considering the capital
budget metrics above. To do this, we can examine the capital budgeting summary of the three
projects below.
Table 4 Capital budgeting comparation of the three projects
Project A has the best NPV, but the lowest IRR out of the three. It also has the biggest
initial investment and longest lifetime period. Project B has the lowest NPV, shortest payback
period, lowest initial investment, and shortest project lifetime. Project C’s figure are in
between project A and project B. To rank these project, we have to use the best criterion in
capital budgeting.
The first criteria to rank independent project is to use NPV, since NPV provide better
assessment for the projects’ value creation and it is superior to other methods (Atrill, 2019).
Other methods may provide beneficial information, but they are not enough to replace the
NPV rule (Ross et al., 2021). For independent investments and simple decisions to accept or
reject, the NPV, the PI, and the IRR are sufficient as figures of merit (Higgins et al., 2022),
however, to rank the alternatives, the three figures will no longer provide the same signal.
NPV is preferable since it provides a direct measure of the expected increase in wealth
generated by the investment.
IRR: 90.36%
PP: 1.23
PI: 4.84
Projects NPV PP PI IRR
Initial
Investment
Lifetime
Project A: Major Equipment Purchase $44,262,269 1.36 5.43 79.79% $10,000,000 8 years
Project B: Expansion into Three Additional States $22,259,712 1.14 3.78 91.48% $8,000,000 5 years
Project C: Marketing or Advertising Campaign $33,470,904 1.23 4.84 90.36% $8,710,521 6 years

10
The major weakness with the PI and the IRR method is that they ignores the scale of
the investment (Higgins et al., 2022). For simple example, IRR method will prefer an 80%
return on a $100 investment over a 50% return on a $1 million investment, which will result
in bad decision. This is also the case with conflicting IRR for project A and project B. Project
A has lower IRR than project B, but it has significantly larger scale of investment, depicted
by the NPV and the initial investment.
Thus, the first choice should be project A. It is the project that will yield the greatest
NPV, which means it will yield the greatest value creation for the company. Its long lifetime
may translate into higher risk, but the team has performed thorough risk analysis and consider
the risk of the project as low, with lowest required rate of return (8%) out of the three
projects. The PP is not significantly different with other projects, and since PP does not really
provide accurate result (it ignores time value of money), we can ignore the small differences.
The second choice should be project C, which provides the second best NPV. Project
B should be the last option since it has the lowest NPV. While having the shortest lifetime,
project B is also considered the most risky out of the three, with the biggest required rate of
return (12%). Project C also has better profitability index than project B which makes it
preferable option.
Conclusion
Based on the capital budgeting analysis above, all of the projects have favorable
outcome. Since the three projects are independent, the company should pursue all three
projects. However, if the company has limited resource and can only choose one or two
projects, then we should choose based on the NPV value. NPV is the best single criterion to
evaluate a project’s potential in improving the company’s value (Brigham & Houston, 2019).
Hence, the rank of the projects that the company should prefer to pursue is as follows:
1. Project A: Major equipment purchase
2. Project C: New marketing or advertising campaign
3. Project B: Expansion to three different states
Nevertheless, all of the methods above provide useful information and all are easy to
calculate. All of the information can be used as an input in decision making, along with
qualitative judgment and common sense.
Further feasibility analysis may be required before the project can be executed, such
as analyzing employee’s training for the new equipment, the social impact it would cause,
and other qualitative analysis. We must acknowledge that noncash-flow factors may have
significant impact in capital budgeting decisions (Ross et al., 2021). Before executing the
project, the company should ensure that the project is feasible quantitatively and
qualitatively.
.

11
References
Atrill, P. (2019). Financial Management for Decision Makers 9th edition (9th ed.). Pearson.
Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management (15th ed.).
Cengage Learning.
Garrison, R., Noreen, E., & Brewer, P. (2018). Managerial Accounting (16th ed.). McGraw-
Hill Education.
Higgins, R. C., Koski, J. L., & Mitton, T. (2022). ISE Analysis for Financial Management
(13th ed.). McGraw Hill.
Merritt, C. (2019). What Is the Impact of Depreciation Expense on Profitability? Small
Business - Chron.Com. https://smallbusiness.chron.com/impact-depreciation-expense-
profitability-55349.html
Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2021). Corporate finance: Core
principles and applications (6th ed.). McGraw-Hill.
Van Dalsem, S. (2017). Capital budgeting cash flows tutorial [Video]
https://www.youtube.com/watch?v=X6HvKl__rLY&t=19s

12
Appendix 1
Projected Cash Flow and Capital Budgets of Investment A
Project A : Major Equipment Purchase
Purchasing cost $10,000,000
Life of project in years 8
Reduction in cost per year 5%
Salvage value $500,000
Required rate of return 8%
Depreciation MACRS-7 years
Annual sales $20,000,000
Earlier Cost of sales (60% of sales) $12,000,000
Tax rate 25%
Year 0 1 2 3 4 5 6 7 8
Purchasing Cost $10,000,000
Annual Sales $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000 $20,000,000
Cost of the goods sold $11,000,000 $10,000,000 $9,000,000 $8,000,000 $7,000,000 $6,000,000 $5,000,000 $4,000,000
MACRS - 7 years rates 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46%
Annual Depreciation $1,429,000 $2,449,000 $1,749,000 $1,249,000 $893,000 $892,000 $893,000 $446,000
Earnings before interest and taxes (EBIT) / Gross Income $7,571,000 $7,551,000 $9,251,000 $10,751,000 $12,107,000 $13,108,000 $14,107,000 $15,554,000
Taxes (25%) / Income Taxes 1,892,750
$ 1,887,750
$ 2,312,750
$ 2,687,750
$ 3,026,750
$ 3,277,000
$ 3,526,750
$ 3,888,500
$
Earnings after taxes / Net Income $5,678,250 $5,663,250 $6,938,250 $8,063,250 $9,080,250 $9,831,000 $10,580,250 $11,665,500
Add Depreciation $1,429,000 $2,449,000 $1,749,000 $1,249,000 $893,000 $892,000 $893,000 $446,000
Add: After tax salvage value $375,000
Cash Flows ($10,000,000) $7,107,250 $8,112,250 $8,687,250 $9,312,250 $9,973,250 $10,723,000 $11,473,250 $12,486,500
Cummulative Cash Flows ($10,000,000) ($2,892,750) $5,219,500 $13,906,750 $23,219,000 $33,192,250 $43,915,250 $55,388,500 $67,875,000
Present Value factor (8%) 1 0.93 0.86 0.79 0.74 0.68 0.63 0.58 0.54
Present value of cash flows ($10,000,000) $6,580,787 $6,954,947 $6,896,219 $6,844,782 $6,787,626 $6,757,309 $6,694,531 $6,746,067
Present value of cash inflows $54,262,269
Present value cash outflows $10,000,000
Net present value = Present value of cash inflows - Present value of cash outflows $44,262,269 NPV Formula: $44,262,269
Internal rate of return (IRR) IRR: 79.79%
Payback period PP: 1.36
profitability Index (PI) + present value of cash inflows/ present value of cash outflows PI: 5.43

13
Appendix 2
Projected Cash Flow and Capital Budgets of Investment B
Start up Cost $7,000,000
Life of a project in years 5
Annual Depreciation (using straightline) $1,400,000
Net working capital $1,000,000
Required rate of Return 12%
Earlier annual sales $20,000,000
Earlier Cost of sales (60% of sales) $12,000,000
Increase in sales and revenue per year 10%
Tax rate 25%
Year 0 1 2 3 4 5
Purchasing Cost $7,000,000
Annual Sales $22,000,000 $24,200,000 $26,620,000 $29,282,000 $32,210,200
Cost of goods sold $13,200,000 $14,520,000 $15,972,000 $17,569,200 $19,326,120
Annual Depreciation $1,400,000 $1,400,000 $1,400,000 $1,400,000 $1,400,000
Earnings before interest and taxes (EBIT) $7,400,000 $8,280,000 $9,248,000 $10,312,800 $11,484,080
Tax (25%) $1,850,000 $2,070,000 $2,312,000 $2,578,200 $2,871,020
Earnings after tax $5,550,000 $6,210,000 $6,936,000 $7,734,600 $8,613,060
Plus Depreciation $1,400,000 $1,400,000 $1,400,000 $1,400,000 $1,400,000
Net working capital ($1,000,000) $1,000,000
Cash flows ($8,000,000) $6,950,000 $7,610,000 $8,336,000 $9,134,600 $11,013,060
Cummulative Cash flows ($8,000,000) ($1,050,000) $6,560,000 $14,896,000 $24,030,600 $35,043,660
Present value factor (12%) 1.00 0.89 0.80 0.71 0.64 0.57
Present value of cash flows ($8,000,000) $6,205,357 $6,066,645 $5,933,400 $5,805,203 $6,249,106
Present Value of Cash outflows $8,000,000
Net Present Value = Present Value of cash inflows - Present Value of cash outflows
$22,259,712 NPV Formula: $22,259,712
Internal rate of return IRR: 91.48%
payback period PP: 1.14
Profitability Index (PI) PI: 3.78
Project B: Expansion Into Three Additional States

14
Appendix 3
Projected Cash Flow and Capital Budgets of Investment C
Project C: Marketuing/ Advertising Campaign
Annual cost $2,000,000
Life of project in years 6
Required rate of return 10%
Earlier Annual sales $20,000,000
Earlier Cost of Sales (60% of sales) $12,000,000
Increase in sales and revenue per year 15%
Tax rate 25%
Year 0 1 2 3 4 5 6
Marketing / Advertising cost $2,000,000 $2,000,000 $2,000,000 $2,000,000 $2,000,000 $2,000,000
Present value of Annual marketing cost $8,710,521
Annual sales $23,000,000 $26,450,000 $30,417,500 $34,980,125 $40,227,144 $46,261,215
Cost of the Goods sold $13,800,000 $15,870,000 $18,250,500 $20,988,075 $24,136,286 $27,756,729
Earnings before interest and taxes (EBIT) $9,200,000 $10,580,000 $12,167,000 $13,992,050 $16,090,858 $18,504,486
Taxes (25%) $2,300,000 $2,645,000 $3,041,750 $3,498,013 $4,022,714 $4,626,122
Earnings after taxes $6,900,000 $7,935,000 $9,125,250 $10,494,038 $12,068,143 $13,878,365
Cash Flows ($8,710,521) $6,900,000 $7,935,000 $9,125,250 $10,494,038 $12,068,143 $13,878,365
Present value factor (10%) 1.00 0.91 0.83 0.75 0.68 0.62 0.56
Present value of cash flows ($8,710,521) $6,272,727 $6,557,851 $6,855,935 $7,167,569 $7,493,367 $7,833,975
Cummulative Cash flows ($8,710,521) ($1,810,521) $6,124,479 $15,249,729 $25,743,766 $37,811,909 $51,690,274
Present value of cash outflows $8,710,521
Net Present Value = Present Value of cash inflows - Present value of cash outflows$33,470,904 NPV Formula: $33,470,904
internal rate of return IRR: 90.36%
Payback periodd PP: 1.23
Profitability Index (PI) = present value of cash inflows/ present value of cash outflows PI: 4.84

Capital Budget Appraisal.

Recommended

Recommended

More Related Content

Similar to Capital Budget Appraisal.

Similar to Capital Budget Appraisal. (20)

Recently uploaded

Recently uploaded (20)

Capital Budget Appraisal.