Question

Capital Budget Problem:

This case continues following the new project of the WePPROMOTE Company, that you and your partner own. WePROMOTE is in the promotional materials business. The project being considered is to manufacture a very unique case for smart phones. The case is very durable, attractive and fits virtually all models of smart phone. It will also have the logo of your client, a prominent, local company and is planned to be given away at public relations events by your client.

More details have emerged and your estimates are becoming more precise.

The following are the new values to the data that you have been estimating up to this point:

1. You can borrow funds from your bank at 3%.

2. The cost to install the needed equipment will be $105,000 and this cost is incurred prior to any cash is received by the project.

3. The gross revenues from the project will be $25,000 for year 1, then $27,000 for years 2 - 4. Year 5 will be $23,000.

4. The expected annual cash outflows (current project costs) are estimated at being $13,000 for the first year, then $12,000 for years 2, 3, and 4. The final year costs will be $10,000.

5. After 5 years the equipment will stop working and will be worthless.

6. The discount rate you are assuming continues to be 6%.

Please set-up solution model for the following capital budget problem. Explain the approach you plan to take and why. Then, please perform the calculations of your model and draw conclusions.​

Answer 1

Since the returns vary each year, we can calculate the et present value of the project to evaluate the project. The Present value can be calculated as follows:

Present value = FV / (1+r)^n , Where FV = Future value cash flow, r = rate of interest and n = year

Year	Inflow	Outflow	Interest	Net cash flow	Present value
0		105,000.00		(105,000.00)	(105,000.00)
1	25,000.00	13,000.00	3,150.00	8,850.00	8,349.06
2	27,000.00	12,000.00	3,150.00	11,850.00	10,546.46
3	27,000.00	12,000.00	3,150.00	11,850.00	9,949.49
4	27,000.00	12,000.00	3,150.00	11,850.00	9,386.31
5	23,000.00	10,000.00	3,150.00	9,850.00	7,360.49
				NPV	(59,408.19)

As the NPV comes to (59408.19), it is not advisable to enter into the project. Also the payback is also not coming for the project.

(Plsease note interest calculated on total loan amount and not assuming any repayments)