In: Finance
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?
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: