This document contains an analysis of a capital budgeting project for Entrepreneur D. It includes calculations of net cash flow for the project with and without depreciation, as well as analyses using several capital budgeting methods. The net present value is positive, the internal rate of return exceeds the required rate, and the accounting rate of return and payback period also indicate the project should be accepted. References are provided.

1. FNT1 Task 2 Capital Budgeting
Hazel Mickle
July 1, 2015

2. Yr 2 with Yr 2 without Dollar Amt
Depreciation Depreciation Difference
Expected annual sales of new product $3,000,000 $3,000,000
Expected costs of new product
Cash expenses $2,300,000 $2,300,000
Depreciation expense $345,000 0
Income before taxes $355,000 $700,000 $345,000
Income tax at marginal rate $113,600 $224,000 $110,400
Net income $241,400 $476,000 $234,600
Net cash flow for one year $586,400 $476,000 ($110,400)

3. Income before taxes $355,000 $700,000 $345,000
Income tax at marginal rate $113,600 $224,000 $110,400
Net income $241,400 $476,000 $234,600
FNT1 Task 2 Capital Budgeting
Hazel Mickle

4. B1.) The correct net cash flow for the second year
without depreciation would be $476,000
B1 a.) I observed that if there is no depreciation
expense the income before taxes are increased. This
change causing income tax liability to go up and that
reduces cash flow.

5. When appraising long term projects, it is important that we
consider the time value of money. One method of capital
budgeting that incorporates this is NPV (Net Present Value).
Based on my analysis, this project yields a positive NPV of
$101,547. I recommend that Entrepreneur D does invest in
this project. A positive NPV means that this project will earn
more income than what would be gained from the discount
rate.
.

6. The analysis prepared shows that this project has an IRR of 12.89% which is
above the required rate of 12%, therefore, it is my suggestion that
Entrepreneur D accepts this investment.
Internal Rate of Return or (IRR) is another capital budgeting model that
considers the time value of money. It is the average rate of return that you
can expect your investment to earn over a period of years. The IRR is the
interest rate that would make the investments Net Present Value equal to
zero (break even).
IRR uses annual cash flow and also uses the total investment outlay. IRR
doesn’t use average net income nor does it use the average book value.

7. The accounting rate of return (ARR) for this project is 20.31%. ARR is a capital
budgeting tool that will measure an assets’ profitability over its entire life. To
calculate ARR; divide the average annual income from the asset by the
average amount invested in the asset. ARR ignores the time value of money
and that is why the (IRR) is different 12.89% for the same investment. ARR
uses average net income and also uses the average book value. ARR doesn’t
use annual cash flow nor does it use the total investment outlay.

8. The payback period for this investment is 5 years and 3 months.
The payback period focuses only on the amount of time it will take to get your
initial investment back; it does not tell you if the investment will be profitable.
The payback period ignores the time value of money. There is significance in
the payback period when there are multiple projects to choose from.
The major Disadvantages of The payback period method
1.Payback ignores the time value of money
2.Payback ignores cash flows beyond the payback period, thereby ignoring
the "profitability" of a project.
3. Payback period does not specify any required comparison to other
investments or even to not making an investment.

9. endeavor.
2. The payback period is an effective measure of investment risk. It is widely used
when liquidity is an important criteria to choose a project.
3.Payback period method is suitable for projects of small investments. It not worth
spending much time and effort in sophisticated economic analysis in such projects.
(from https://www.boundless.com/finance/textbooks/boundless-finance-
textbook/capital-budgeting-11/the-payback-method-92/advantages-of-the-payback-
method-399-4854/ )
The calculation used to derive the payback period is called the payback method.
The formula for the payback method is to divide the cash outlay (which is assumed to occur entirely at the
beginning of the project) by the amount of net cash flow generated by the project per year (which is assumed
to be the same in every year) .
T he payback method should not be used as the sole criterion for approval of a capital investment. The NPV
or IRR methods should be used for the time value of money and more complex cash flows, and use to see if
the investment will actually boost overall corporate profitability. (Payback Period Formula - AccountingTools.
(n.d.). Retrieved July 8, 2015. )

10. In Net Present Value (NPV) analysis the WACC is used to find the
Present Value (PV 12%) that is used to discount the cash flows to the
present value. Once the total present value is calculated the
investment amount is subtracted out to arrive at the Net Present
Value (NPV).

11. Internal rate of return tells you the amount of growth (income) a project is
expected to return. When Performing the IRR method in capital budgeting
analysis, the WACC should be used as the required minimum return
amount. If the IRR rate falls below the WACC then a company should not
invest in the project

12. References
1. Boundless. “Disadvantages of the Payback
Method.” Boundless Finance. Boundless, 01
Jul. 2015. Retrieved 07 Jul. 2015
2. Boundless. “Advantages of the Payback
Method.” Boundless Finance. Boundless,
01 Jul. 2015. Retrieved 07 Jul. 2015
3. Payback Period Formula -
AccountingTools. (n.d.). Retrieved July 8,
2015.