Question

Problem 3 – Capital Budgeting

This is where an MS Excel model might come in handy.

Remember to use a very clear title and heading including your name on the page if you submit a separate MS Excel file. Follow the format I used in the examples that I sent out in the capital budgeting teaching notes document.


Mumford Company is planning an upgrade to its warehouse. The upgrade involves computerizing many of the material handling activities. The cost of the upgrade is expected to be $2,800,000. The equipment falls into the 7 year IRS depreciation category (straight line method full year depreciation every year) and is expected to provide annual cash cost (primarily labor related) savings totaling $750,000 for each year over the next 8 years. Mumford is in the 30% tax bracket and has decided to use a 12% hurdle rate, as a first pass, to calculate the Net Present Value and begin to examine the financial viability of the proposed project. At the end of years 3 and 6 a software upgrade costing $50,000 (each year) will be made. These expenditures are fully tax deductible in the years paid. Years 3 and 6.

1. Prepare a well organized schedule that concludes with the calculation of the expected NPV from this project. Be sure that your schedule is well organized.
2. Is the Internal Rate of Return on the Project more or less than the 12% Hurdle Rate?

Answer 1

1. NPV at the hurdle rate of 12%= $313,017.26

2. IRR= 15.19% which is more than the 12% hurdle rate.

Schedule of ca;lculation of NPV and IRR as follows: