Capital Budgeting Essay

i. What is capital budgeting?

Capital budgeting is the process of allocating, or budgeting a capital and fixed asset of a firm, or corporation such as buildings, new machines, new plants, or new products for an investment purpose by evaluating its cash inflows and outflows in order to derive future payment which is higher than the current commitment. It concerned with what long-term investment should a firm or corporation take? What capital should a firm or corporation invest in?

ii. What is the difference between independent and mutually exclusive projects? Between projects with normal and non-normal cash flows.

The difference between independent project and mutually exclusive projects is that an independent project is one where the acceptance

When the time value of money being ignored, it may lead us to take investment that actually worth less than they cost. By ignoring the cash flow beyond payback period, it may lead us to reject profitable long term investment or project that might be more valuable than another based on future cash flows. More generally, using a payback period rule will tend to bias us towards short-term

It is also known as benefit-cost ratio. We accept an investment with the profitability index that bigger than 1.0 and reject for profitability index which is lower than due to any value lower than 1.0 would indicate that the project's present value is less than the initial investment.

vii. From the information given, calculate the payback period, Net Present Value (NPV), Profitability Index (PI) and Internal Rate of Return (IRR) of GoodTime Co investment project.

Research and development costs = $ 20 million

Market testing expenses = $ 5 million

Number of years expected to stay = 4 years

Initial investment in production equipment = $ 150 million

Equipment can be sold for $ 50 million each year

Original manufacturer market = Sell for $ 40, variable cost = $ 25, profit = $ 15 each

Replacement market = Sell for $ 50, variable cost = $ 25, profit = $ 25 each

Marketing and general administrative cost = $ 25 million in first year, increase at the inflation rate

Price of new tire increase at inflation rate

Annual inflation rate = 3.5 %, Variable cost increase at 4.5 %

Original market >> New car this year = 5.5 million and grow at 2.5 % each year, each car need 4 tire, capture 10 %

Replacement market >> 15 million tires and grow at 2 % each year, capture 8 %

Equipment depreciated on 7