2. CURRENT FINANCIAL CONDITION OF THE COMPANY
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%
ABC is evaluating three projects that can help scale up the organization
Major equipment purchase
Expansion to three additional states
New marketing campaign
These three projects are independent, ABC can choose to execute all
3. Project B: Expansion Into Three Additional States
Start up Cost $7,000,000
Life of a project in years 5
Annual Depreciation (using straight line) $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%
Project C: Marketing/ 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%
4. CAPITAL BUDGETING TOOLS
PROJECT A
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
This report comprises the capital budgeting tools that are utilized to evaluate each project:
Net present value analysis (NPV)
Internal rate of return (IRR)
Payback period
Profitability index (PI)
The project is considered a relatively safe investment, and so the financial team considered the
appropriate required rate of return for the project is 8%. The tax rate will be presumed to be 25%.
5. Project C
Net Present Value = Present Value of cash inflows - Present value of
cash outflows $33,470,904NPV 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
The project is considered a relatively somewhat risky investment, and so the financial team considered
the appropriate required rate of return for the project as 12%. The tax rate will be presumed to be 25%.
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
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%.
6. ANALYSIS AND RECOMMENDATION
The three projects yield positive NPVs and high IRRs that are
greater than the required rate of return for each project.
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 the short break-even point.
Projects are independent, the company can choose to
execute all three if it has the resources.
7. If limited resources, rank the projects, and the project will provide the best value for shareholders considering
the capital budget metrics. We can examine the capital budgeting summary of the three projects below.
ANALYSIS AND RECOMMENDATION
Project A has the best NPV, but the lowest IRR out of the three. It 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 figures are in between project A and project B. To rank these projects, we have to use the best
criterion in capital budgeting.
8. CONCLUSION
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
Further feasibility analysis may be required before the project can be executed, such as analyzing
employees’ training for the new equipment, the social impact it would cause, and other qualitative
analyses.