Reference no: EM132372303

Assignment: Capital Budgeting

Answer the two problems below (P1 and P2). Five marks each. Part marks will be allocated.

Project 1 Calculations must be done in Excel

The financial advisor to PQR Company is evaluating whether to keep company cars for 3, 4, 5 or 6 years. The following information has been gathered:-

A car costs $80,000 and depreciation is 25% pa straight-line.
Cash expenses are $20,000 per year for the first 2 years, $30,000 in year 3, $40,000 in year 4, $50,000 in year 5 and $60,000 in year 6.
The salvage value is expected to be $30,000 after 3 years, $25,000 after 4 years, $20,000 after 5 years and $10,000 after 6 years.
The after tax required rate of return is 10% pa and the tax rate is 30%.

Required
Prepare an analysis to decide whether company cars should be kept for 3, 4, 5 or 6 years before being replaced with new ones.

Project 2 Calculations must be done in Excel - You must create your own spreadsheet do not copy and paste someone else's.

Jean Smith, the financial advisor to Creative Manufacturing is evaluating the following new investment in a manufacturing project:-

The project has a useful life of 8 years.
Land costs $10m and is estimated to have a resale value of $13m at the completion of the project.
Buildings cost $5m, with allowable depreciation of 10% pa reducing balance and a salvage value of $1m.
Equipment costs $4m, with allowable depreciation of 30% pa reducing balance and a salvage value of $1.5m. An investment allowance of 20% of the equipment cost is available.
Revenues are expected to be $8m for the first 4 years and $9m for the next 4 years.
Cash expenses are estimated at $4m in year one and rise at 4% pa.
The new product will be charged $400,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project.
An amount of $100,000 has been spent on a feasibility study for the new project.
The project is to be partially financed with a loan of $10m to be repaid annually with equal instalments at a rate of 5% pa over 8 years.
Except for initial outlays, assume cash flows occur at the end of each year.
The tax rate is 30% and is payable in the year in which profit is earned.
The after tax required return for the project is 12% pa.

Required
(a) Calculate the NPV. Is the project acceptable? Why or why not?
(b) Conduct a sensitivity analysis showing how sensitive the project is to revenues, the resale value of the land and to the required rate of return. Explain your results.