Question

ABC Stores is planning its store expansion for this year's capital budget. They have five potential locations, but there is a hard limit of $27.5 million on the amount that can be spent year on expansion. ABC wants to pick the best package of store expansions, given the six-year financial projections shown in the table below. Because of differences in state laws, local tax incentives, build-versus-lease options, and local economic conditions, the annual cash flow projections for the five potential locations differ significantly. Terminal values have already been incorporated into the After-Tax Operating Cash Flows for Year 6 so they do not require a separate calculation. The numbers in the table are in thousands of dollars. A junior analyst has calculated several capital budgeting metrics, based on the data in the table and a capital cost of 12%, and now it is up to you to make a recommendation. Using financial principles, what do you recommend for this year's capital budget. Provide a justification that senior management can understand. Atlanta Boston Charleston Dallas Evanston

Atlanta Boston Charleston Dallas Evanston

Initial Investment ($12,250)   ($11,200) ($14,200) ($14,400) ($21,450)

After-tax Operating Cash Flow, Year 1 $3,773 $2,233   $6,042 $926 $15,327 -

After-tax Operating Cash Flow, Year 2 $3,509 $2,552 $4,851 $1,122 $9,589 -

After-tax Operating Cash Flow, Year 3 $3,597 $3,080 $4,378 $1,927 $3,311 -

After-tax Operating Cash Flow, Year 4 $3,586 $4,620 $4,002 $5,570 $1,822

After-tax Operating Cash Flow, Year 5 $3,254 $4,833 $1,978 $6,300 $1,079

After-tax Operating Cash Flow, Year 6 $3,875 $4,930 $1,430 $15,719 $522

Net Present Value (NPV) $2,565 $3,197 $2,568 $3,771 $4,270

Internal Rate of Return (IRR) 19.2% 20.1% 19.8% 17.7% 24.6%

Modified Internal Rate of Return (MIRR) 15.6% 16.8% 15.1% 16.4% 15.4%

Profitability Index (PI) 1.21 1.29 1.18 1.26 1.20

Payback Period 3.38 years 3.72 years 2.76 years 4.77 years 1.64 years

Answer 1

Budget limit=			27.5 million
Ultimate object of company to maximize its wealth. If from the implementation of project, wealth of company increases, it should accept project.
Ultimately wealth should increase. Wealth increase when benefits from projects are greater than cost. It is measured in terms of NPV.
When there are limitation of budget, Profitability index is always useful for determining which project should be commenced and which not.
Project having Higher P.I. must be given priority and and so on.
	Atlanta	Boston	Charleston	Dallas	Evanston
P.I.	1.21	1.29	1.18	1.26	1.2
Priority	3rd	1st	5th	2nd	4th
So, first location selected is Boston, then Dollas, then altlanta, then Evanson and then Charleston.
Accordingly, amount should be invested.