Capital Budgeting: Discounted Cash Flow Analysis Case Study Analysis
Introduction
Capital Budgeting and DCF Analysis
capital budgeting is the process used by the business to evaluate the profitability of current and future projects. This case includes 7 exercises collectively that are related to cash flow analysis and capital budgeting analysis.
(Thomas, 1997).
Q.01 Net Present Value (NPV), Internal Rate of Return (IRR) and Payback Period
| Price of Machine | 500000 |
| Cash cost saving | 200000 |
| Years | 5 |
| Salvage Value | 75000 |
| Tax rate | 40% |
| Discount rate | 8% |
| Depreciable cost | 425000 |
| Annual Depreciation | 85000 |
| Net Present Value | $165,921.09 |
| IRR | 19% |
| Payback Period | 3.2 |
After analyzing the values and requirements of the course instructor we do the calculations and find these results.
NPV $165,921.09
NPV signifies the variance concerning the original investment and the PV of expected cash flows. In this case, the project seems profitable because the NPV is positive.
IRR 19%
IRR is the proportion at which the venture breaks even (NPV equals zero). An IRR of 19% specifies that the project is projected to deliver a profit of 8% (the discount rate used), which is a good sign.
The analysis suggests that the investment in this machine is financially viable and profitable. The positive NPV and IRR above the discount rate indicate that the project is expected to generate positive returns. Additionally, the payback period is relatively short about 3.2 years indicating a quick return on the investment.
Q.02 Three-handed loaded machine and Automatic Mining Machine
| Hand loaded blocks | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 | 13 | 14 | 15 |
| Cash In | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 |
| Cash-out | ||||||||||||
| Actual after-tax cash flow | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 |
| No of years for calculating PV | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 |
| Present Value | 8000 | 7477 | 6988 | 6530 | 6103 | 5704 | 5331 | 4982 | 4656 | 4351 | 4067 | 3801 |
| Net Present Value | 67989 | |||||||||||
| Automatic Mining | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 | 12 | 13 | 14 | 15 |
| Cash In | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 |
| Cash-out | 480000 | |||||||||||
| Actual after-tax cash flow | -365,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 | 115,000 |
| No of years for calculating PV | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 |
| Present Value | -365,000 | 107477 | 100445 | 93874 | 87733 | 81993 | 76629 | 71616 | 66931 | 62552 | 58460 | 54636 |
| Net Present Value | 497,348 |
Recommendation
Based on the NPV analysis, the Automatic Mining Machine investment appears to be a better choice from a financial perspective because the value of this alternative is higher than hand-loaded blocks.
Q.03 Product line should continue or not
| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | |
| Year | 1998 | 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | |
| Units | 1000000 | 1000000 | 1000000 | 1000000 | 1000000 | 1000000 | 1000000 | |
| Unit price | 20 | 20.6 | 21 | 21.15 | 21.25 | 21.25 | 21 | |
| Sales | 20000000 | 20600000 | 21000000 | 21150000 | 21250000 | 21250000 | 21000000 | 0 |
| COGS | 10000000 | 10300000 | 10609000 | 10927270 | 11255088 | 11592741 | 11940523 | |
| Depreciation | 1057000 | 1124000 | 1204000 | 1304000 | 1404000 | 1504000 | 1504000 | 1504000 |
| GP | 8943000 | 9176000 | 9187000 | 8918730 | 8590912 | 8153259 | 7555477 | |
| SGA | 7000000 | 7210000 | 7426300 | 7649089 | 7878562 | 8114919 | 8358366 | |
| EBIT | 1943000 | 1966000 | 1760700 | 1269641 | 712350.2 | 38340.74 | -802889 | |
| TAX 40% | 777200 | 786400 | 704280 | 507856.4 | 284940.1 | 15336.29 | -321156 | |
| EBIAT | 1165800 | 1179600 | 1056420 | 761784.6 | 427410.1 | 23004.44 | -481733 | |
| NOPAT | 1165800 | 1179600 | 1056420 | 761784.6 | 427410.1 | 23004.44 | -481733 | |
| Add Depreciation | 1057000 | 1124000 | 1204000 | 1304000 | 1404000 | 1504000 | 1504000 | |
| Less CapEx | -400000 | -400000 | -400000 | -400000 | -300000 | -200000 | 0 | |
| Less Change WC | -108000 | -111000 | -79000 | -40000 | -33000 | -17000 | 23000 | 3957000 |
| Free Cash flow | 1714800 | 1792600 | 1781420 | 1625785 | 1498410 | 1310004 | 1045267 | 3957000 |
| DCF | 1531071.429 | 1429050 | 1267980 | 1033216 | 850238.2 | 663689 | 472825.5 | 1598165.933 |
| NPV | $8,846,234.87 | |||||||
| If we Discontinue now | ||||||||
| Sale offered Assets | $3,000,000.00 | |||||||
| Tax Benefit on loss | $1,600,000.00 | |||||||
| Recovery of Working Capital | $3,592,000.00 | |||||||
| Net Cash Flow | $8,192,000.00 |
From the above calculations and interpreting the results we can recommend that the production line must be continued because it has a positive economic effect on profitability. The NPV is positive and higher which means it is also beneficial for upcoming time.
Q.04 Special Promotion Program
| Year | 1998 | 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 |
| Units | 250 | 250 | 250 | 250 | 250 | 250 | 250 | |
| Unit price | 20.00 | 20.60 | 21.00 | 21.15 | 21.25 | 21.25 | 21.00 | |
| Capex | 1400.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 | |
| Sales | 5,000,000 | 5,150,000 | 5,250,000 | 5,288,500 | 5,312,500 | 5,312,500 | 5,250,000 | |
| Cash COGS | 2,500,000 | 2,575,000 | 2,652,250 | 2,731,818 | 2,813,772 | 2,898,185 | 2,985,131 | |
| Depreciation | 200,000 | 200,000 | 200,000 | 200,000 | 200,000 | 200,000 | 200,000 | |
| Gross profit | 2300000 | 2375000 | 2397750 | 2356682 | 2298728 | 2214315 | 2064869 | |
| Sell | 1,250,000 | 1,287,500 | 1,326,125 | 1,365,909 | 1,406,886 | 1,449,093 | 1,492,565 | |
| Special promotion | 1,000,000 | 1,000,000 | 500,000 | 0 | 0 | 0 | 0 | |
| EBIT | 50000 | 87500 | 571625 | 990,773 | 891842 | 765222 | 572304 | |
| Tax 40% | 20000 | 35000 | 228650 | 396309.2 | 356736.8 | 306088.8 | 228922 | |
| EBIAT | 30000 | 52500 | 342975 | 594464 | 535105 | 459133 | 343382 | |
| Change in WC | 28.00 | 20.00 | 10.00 | 8.00 | 4.00 | 6.00 | 989.00 | |
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