Question

You are the financial manager of Walnut Grove City, a small mid-eastern town, and in charge of creating a capital budget for the next year. The only project on the agenda is building a clock tower within the city square and expanding the adjacent park for small events. You must incorporate into the budget the expense of building a clock tower in the city's town square and adjacent park, and may choose the size, exact location and materials to be used. The expense for the clock tower is estimated to be $400,000 and clean-up of the adjacent park is estimated to be $50,000. After the expansion, three events are planned: 1. Street party celebrating the new clock tower and park which will continue as an anniversary party every year thereafter, and is expected to have a net income of $75,000; 2. Fourth of July fireworks celebration with expected net income of $125,000; and 3. Labor Day carnival to celebrate going back to school and harvest which is expected to have a net income of $50,000. All three events will be continued each following year.

Explain the five capital budgeting steps you will use and how each step will be associated with the clock tower project.

Answer 1

Five Capital Budgeting Steps:

.1. Identify and evaluate potential opportunities:

Potential opportunity is the clocktower project

.2. Estimate operating and implementation costs

Expense for the clocktower:$400,000

Cost of Clean up of adjacent park:$50,000

Total initial Cost:$450,000

                .3. Estimate cash flow or benefit

                  Benefits:

                  1.Street party:$75,000 per year

                  2.Fire works celebration :$125,000per year

                 3.Labor day carnival:$50,000   per year

                   TOTAL BENEFITS:$250,000 per year

                .4. Assess risk:

                  Based on risk assessment and cost of fund , you decide the discount rate. Assume the discount rate is 10%

                   Present Value of Benefits =$250000/0.1=$2,500,000

                   Benefit /Cost ratio =2500000/450000=5.55

.5. Implement:

Based on the evaluation of costs and benefit , if you decide to implement, you need to prepare implementation plan.

The plan should include ,schedule of implementation, resources required at various point of time, methods of resource mobilization, method of monitoring progress