Capital Budget Analysis Based on the inputs below prepare a capital budget analy
ID: 2740236 • Letter: C
Question
Capital Budget Analysis
Based on the inputs below prepare a capital budget analysis for this Base Case using the Net Present Value, Internal Rate of Return, Profitability Index and Payback in Years determining whether the project is feasible.
Project Inputs:
WACC – the cost of capital (hurdle rate) will be the current yield of the 10 Year U.S. Treasury Note as of Tuesday July 5, 2016, plus 700 basis points (Please explain how you calculated it in details).
Project Investment Outlay, Year 0 - $400,000
Project Investment Life – 10 years
Project Depreciation - $40,000 / year
Project Salvage Value - $10,000
Working Capital Base of Annual Sales – 10%
Expected inflation rate per year, Selling Price Per Unit – 5%
Expected inflation rate per year, Manufacturing Cost per unit – 3.5%
Expected inflation rate per year, Fixed operating costs per year – 2.5%
Project Tax Rate – 30%
Units sold per year – 50,000
Selling Price per Unit, Year 1 - $35
Fixed operating costs per year excluding depreciation - $150,000
Manufacturing costs per unit, Year 1 - $25.20
Explanation / Answer
WACC – the cost of capital (hurdle rate) will be the current yield of the 10 Year U.S. Treasury Note as of Tuesday July 5, 2016, plus 700 basis points - Input taken from from following reference
https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
!0 year rate of 5th July 2016 is 1.37 plus 70 point i.e. 0.07 hence cost of capital comes to 2.07, this rate is used for calculating cost of capital.
Year 0 1 2 3 4 5 6 7 8 9 10 Project investment Outlay -4,00,000 Depreciation -40,000 -40,000 -40,000 -40,000 -40,000 -40,000 -40,000 -40,000 -40,000 -40,000 Cost of capital -8,280 -8,280 -8,280 -8,280 -8,280 -8,280 -8,280 -8,280 -8,280 -8,280 Salvage cost 10,000 Sales 17,50,000 18,37,500 19,29,375 20,25,844 21,27,136 22,33,493 23,45,167 24,62,426 25,85,547 27,14,824 Working cap -1,75,000 -1,83,750 -1,92,938 -2,02,584 -2,12,714 -2,23,349 -2,34,517 -2,46,243 -2,58,555 -2,71,482 Operating cost -1,50,000 -1,53,750 -1,57,594 -1,61,534 -1,65,572 -1,69,711 -1,73,954 -1,78,303 -1,82,760 -1,87,329 Manufacturing cost -12,60,000 -13,04,100 -13,49,744 -13,96,985 -14,45,879 -14,96,485 -15,48,862 -16,03,072 -16,59,179 -17,17,251 Tax -35,016 -44,286 -54,246 -64,938 -76,407 -88,700 -1,01,866 -1,15,959 -1,31,032 -1,50,145 Net Profit 81,704 1,03,334 1,26,574 1,51,523 1,78,284 2,06,967 2,37,688 2,70,570 3,05,741 3,50,337 PV 80,047 1,01,238 1,24,007 1,48,450 1,74,668 2,02,770 2,32,868 2,65,083 2,99,540 3,43,232 Profitability Index 20% 25% 31% 37% 44% 51% 58% 66% 75% 86% Net Cashflow 1,20,047 1,41,238 1,64,007 1,88,450 2,14,668 2,42,770 2,72,868 3,05,083 3,39,540 3,83,232 Total Cash flow 23,71,904 Payback Period (in Years) Project investment / total of net cashflow 0.17