Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 72

Sensitivity Analysis Griffey&Son operate a plant in Cincinnati and are considering opening a new facility in Seattle. The initial outlay will be $3,500,000 and should produce after-tax net cash inflows of $600,000 per year for 15 years. Due to the effects of the ocean air in Seattle, however, the plant’s useful life may be only 12 years. Cost of capital is 14 percent.

Required

1. Will the project be accepted if 15 years’ useful life is assumed? What if 12 years of useful life is used?

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2. How many years will be needed for the Seattle facility to earn at least a 14 percent return?

Step 1 of 5

Capital Budgeting is a process used to evaluate the various available projects to decide which project is to be proceeded with. First of all, we start process of capital budgeting with forecasting of future inflows and outflows of available projects. It is determined that what effect will it make on cash flows of the firm, and then NPV of project is calculated to determine how it would affect the value of firm. Net Present Value (NPV) means difference between present value of all inflows resulting from project and present value of outflows resulting from such project.