ADVANCED FINANCIAL MANAGEMENT ASSIGNMENT CASE STUDY
Application of Capital Budgeting Decision Rules
Company X is proposing the following capital budgeting project:
Total depreciable cost
- Equipment: $220,000
- Shipping and installation: $30,000
Changes in working capital
- Inventories will rise by $25,000
- Accounts payable will rise by $5,000
Effect on operations
- New sales: 100,000 units/year @ $2/unit
- Variable cost: 60% of sales
Life of the project
- Economic life: 4 years
- Depreciable life: ACRS 3-year class
- Salvage value: $25,000
Tax rate: 40%
WACC: 11%
Determining Project Value -
Estimate the relevant cash flows recited to the project:
- Calculating annual operating cash flows (OCF)
- Identifying changes in working capital (NWC).
- Calculating terminal cash flows (TCF) that includes after-tax salvage value and return (reimbursement) of NWC.
After you solve the case, please, shortly answer to the following questions:
1. What is the role of NWC? How is NWC recovered in the last year?
2. How do we define Salvage Value? Is there always taxes on Salvage Value and when?
3. Should financing effects (interest, dividend) be included in cash flows? If yes, why?
4. What decision should be taken by the management based on your results? Which of the capital budgeting rules is most widely used?