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

Exercise 42

Basic Capital-Budgeting Techniques, No Taxes, Uniform Net Cash Inflows Irv Nelson, Inc., purchased a $500,000 machine to manufacture specialty taps for electrical equipment. Nelson expects to sell all it can manufacture in the next 10 years. To encourage capital investments, the government has exempted taxes on profits from new investments. This legislation is to be in effect in the foreseeable future. The machine is expected to have a 10-year useful life with no salvage value. Nelson uses straight-line depreciation. The net cash inflow is expected to be $120,000 each year for 10 years. Nelson uses a 12 percent discount rate in evaluating capital investments. Assume, for simplicity, that MACRS depreciation rules do not apply.

Required Using Excel, compute for the proposed capital investment the:

1. Payback period under the assumption that cash inflows occur evenly throughout the year.

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2. Book rate of return based on (a) initial investment and (b) average investment.

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3. Net present value (NPV) of the proposed investment under the assumption that cash inflows occur at year-end.

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4. Present value payback period of the proposed investment under the assumption that cash inflows occur evenly throughout the year.

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5. Internal rate of return (IRR).

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6. Modified internal rate of return (MIRR).

Step 1 of 11

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.