TASK: Capital budgeting - planning investments
Objectives
To be able to identify how managers plan significant investments in potential projects than can actually be funded which have long-term
implications on an organisation.
The management of Popular Stores Sdn. Bhd. are in the process of exploring the company's investment opportunities.
There are six opportunities, the details and relevant information for which is as follows:
Project A would cost $29 000 now, and would generate the following cash flows:
|
Year
|
$
|
|
1
|
8,000
|
|
2
|
12,000
|
|
3
|
10,000
|
|
4
|
6,000
|
The equipment included in the cost of the investment could be resold for $5,000 at the start of year 5.
Project B would involve a current outlay of $44,000 on capital equipment and $20,000 on working capital.
The profits from the project would be as follows:
|
Year
|
Sales $
|
Variable Costs $
|
Contribution $
|
Fixed Cost $
|
Profit $
|
|
1
|
75,000
|
50,000
|
25,000
|
10,000
|
15,000
|
|
2
|
90,000
|
60,000
|
30,000
|
10,000
|
20,000
|
|
3
|
42,000
|
28,000
|
14,000
|
8,000
|
6,000
|
Fixed costs include an annual charge of $4,000 for depreciation; all the other fixed costs are avoidable. At the end of year 3 the working capital investment would be recovered and the equipment would be sold for $5,000.
Project C would involve a current outlay of $50,000 on equipment and $15,000 on working capital. The investment in working capital would be increased to $21,000 at the end of the first year. Annual cash profits would be $18,000 per annum for five years, at the end of which the
investment in working capital would be recovered.
Project D would involve an outlay of $20,000 now and a further outlay of$20,000 after one year. Cash profits thereafter would be as follows:
|
Year
|
$
|
|
2
|
15,000
|
|
3
|
12,000
|
|
4-8
|
8,000
|
|
per annum
|
Project E is a long-term project involving an immediate outlay of $32,000 and annual cash profits of $4,500 per annum in perpetuity.
Project F is another long-term project, involving an immediate outlay of $20,000 and annual cash profits as follows:
|
Year
|
$
|
|
1-5
|
5,000
|
|
6-10
|
4,000
|
|
11
|
3,000
|
|
per annum
|
The company discounts all projects of ten years' duration or less at a cost of capital of 12%, and all longer projects at a cost of 15%.
You are required to calculate the:
(a) NPV of each project, and determine which should be undertaken by the company.
(b) IRR of projects A, C and E and recommendation with reasons whether each project should be undertaken based on IRR computed.
(c) Discounted and non-discounted payback periods of project A.
(d) Accounting rate of return for project A. Assume that the depreciation charge is on a straight line basis.