Question

prepare a capital budget for a project such as building or renovating a facility.

Required:

Determine the total cost of the project and the source of funds for the project.

Did the cost of the project stay within budget?

If the present value method was used, review the calculations. Do you agree with the calculations and methods used?

If the present value was not used to evaluate the project, estimate the project’s net present value.

Evaluate the capital budgeting procedures that were actually used by your university.

Answer 1

I am taking simple figures. Lets say a company wants to build a plant and the cost is $ 50,000 and $ 50,000 in year 1 and year 2 which will be arranged from loan. after such building the plant will fetch $ 20,000 a year. and the estimated useful life of the plant is 6 years. after that its residual value will remain $ 10,000. let the discounting rate or present value factor be 10%.

Net Present Value = Present value of cash inflow - Present value of cash outflow

= $ 95455 - $ 92720

= - $ 2735 or ( 2735 )

here cash outflow is greater than cash inflow, therefore NPV is negative i.e it is not ideal to invest in such project.

IRR, payback period, PI index etc can also be used but NPV is the best method , it considers the present value of future cash flows. consider risk factors and is a good measure of profitability.

present value of cash outflow = $ 95455

year	cost/outflow	PV factor	amount
1	50,000	1	50,000
2	50,000	0.909	45,455
		Total	95,455

present value of cash inflow = $ 92720

year	income/inflow	PV factor	amount
1	20000	0.909	18,180
2	20000	0.826	16,520
3	20000	0.751	15,020
4	20000	0.683	13,660
5	20000	0.621	12,420
6	20000	0.564	11,280
residual	10000	0.564	5,640
		Total	92,720