Part 3: Capital Budgeting and Project Evaluation Case Study: Assume that the company, where you are working as a team in Financial Department, is considering a potential project with a new product. It will require the company to buy a new equipment that will generate the same revenue for the company each year. The table below shows the initial and annual costs for each option. 3.1. Capital Budgeting Decision Making: Perform capital budgeting technique based on Equivalent Annual Cost (EAC) to advise the Company Management which option should be chosen if the relevant discount rate is 9%? Costs Option A Option B Initial Investment 1,400,000 1,500,000 Year 1 35,000 25,000 Year 2 35,000 25,000 Year 3 35,000 25,000 Year 4 35,000 25,000 Year 5 25,000
Part 3: Capital Budgeting and Project Evaluation
Case Study: Assume that the company, where you are working as a team in Financial Department, is considering a potential project with a new product. It will require the company to buy a new equipment that will generate the same revenue for the company each year. The table below shows the initial and annual costs for each option.
3.1. Capital Budgeting Decision Making: Perform capital budgeting technique based on Equivalent Annual Cost (EAC) to advise the Company Management which option should be chosen if the relevant discount rate is 9%?
|
Costs |
Option A |
Option B |
|
Initial Investment |
1,400,000 |
1,500,000 |
|
Year 1 |
35,000 |
25,000 |
|
Year 2 |
35,000 |
25,000 |
|
Year 3 |
35,000 |
25,000 |
|
Year 4 |
35,000 |
25,000 |
|
Year 5 |
25,000 |
3.2. Risk Analysis and Project evaluation:
Assume that the company finally chose Option B. It expects to sell 600,000 units of the new product for an average price of $15 per unit. The Equipment in Option B has a residual value of $300 000 at the end of the project. The company will need to add $ 750 000 in working capital which is expected to be fully retrieved at the end of the project. Other information is available below:
Depreciation method: straight line Variable cost per unit: $10.5 Cash fixed costs per year: $25 000 Discount rate: 9% Tax Rate: 30%
Upon consideration of unexpected economic conditions, the company management requires your Team to prepare a risk analysis to evaluate the outcome of potential project when the values drivers of the project changes by 20%.
Required: identify the value drivers of the project cash flows, do a sensitivity analysis and provide the management with a sensitive analysis report which shows how
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