Capital Budgeting and Investment Decisions

Question: Discuss about the Capital Budgeting and Investment Decisions. Answer: Introduction: The issues on capital budgeting includes expansion of cricket apparel and replacement of lighting system of the warehouse because the existing lighting system was overloaded. First issue in the present situation involves investment opportunity in cricket apparel since the market trends provides stability in the present economy (Dellavigna and Pollet 2013). Another option in the first issue involves leasing of building along with the acquisition of plant and equipments. Considering the situation, analysis on capital budgeting would be considered using the method of Net Present Value, which is determined as the difference between present value of cash inflows and outflows (Gtze, Northcott and Schuster 2015). If the outcome is positive, it indicates the project is worth considering since it generates earnings using the concept of time value of money. The project on cricket apparel expansion incorporates investment of $85,000 along with the investment in plant and equipment costing $350,000 for the period of five years. Amount $ Year 1 Year 2 Year 3 Year 4 Year 5 Investment amount 85,000 plant and equipment 350,000 Depreciation @15% 48,150 ($350,000- $29,000) * 15% Sales 280,000 316,400 357,532 343,231 329,501 Cost of the project 150,000 153,000 156,060 159,181 162,365 Discounting rate 14% 0.877 0.769 0.674 0.592 0.519 Present values: Sales 245,560 243,312 240,977 203,193 171,011 Fixed Cost of the project 131,550 117,657 105,184 94,235 84,267 Variable cost 11% of revenue 27,012 26,764 26,507 22,351 18,811 Investment amount 74,545 Plant and equipment 306,950 Net present value (Total inflow - total outflow) -294,497 98,890 109,285 86,606 67,933 Total net present value 68,217 (Source: Created by Author) Considering the determination of net present value from the proposed project, it has been measured that the outcome is positive $68,217 hence acceptance of project is recommended. Further, the applicable tax rate is 30% that provides net expected profit amounted to $68,217* 70% = $47,752. Moreover, it has been estimated that projected sales would decline by 4% during fourth and fifth years while increase in sales in the initial years was 13%. Estimated working capital for operating the project involves 12% on the sales revenue of the subsequent year and estimated profit after tax amounted to $15,000 would be cannibalized from the existing business. Therefore, net profit after considering the cannibalizing amounted to $47,752- $15,000 = $32,752 which is positive hence, the project is recommended to be accepted. Considering the second issue on replacement of warehouse lighting system, three different systems have been considered. All the three different systems have different useful life therefore, annualized net present value will be considered to determine the most feasible system that can be implemented for replacing the lighting system (Zhang, Huang and Zhang 2015). Cost Useful life Net cash outflow $ Annuity factor @14% Present value of cash outflow Total outflow Annualized cash outflow First system $7,000 5 years 800 per year 3.431 2744.8 $9,745 $1,948.96 Second system $10,500 10 years 700 per year 8.511 5957.7 $16,458 $1,645.77 Third system $17,500 20 years 80 per year 10.822 865.76 $18,366 $918.29 (Source: Created by Author) Annualized net present value is considered when the project has different duration accordingly, in the present issue three different systems have unequal duration (Doss et al. 2015). As per the calculation, it has been observed that the total net cash outflow is least in the third system amounted to $918.29 whereas replacement cost in other two systems is high. In addition, annual cash outflow in the third system is also least compared to other two systems amounted to $800 and $700 respectively even though the initial investment cost is highest in the third system. Further, the useful life expectancy in first two systems is less than that of third system, accordingly, it can be said that the operating activity of third system will be more beneficial and is recommended to be replaced. Reference List Dellavigna, S. and Pollet, J.M., 2013. Capital budgeting versus market timing: An evaluation using demographics.The Journal of Finance,68(1), pp.237-270. Doss, D.A., Jones, D.W., Sumrall, W., Henley, R., McElreath, D., Lackey, H. and Gokaraju, B., 2015. A net present worth analysis of considered academic programs at a private, regional higher education institution.Journal of Interdisciplinary Studies in Education,4(1), p.55. Gtze, U., Northcott, D. and Schuster, P., 2015. Capital Budgeting and Investment Decisions. InInvestment Appraisal(pp. 3-26). Springer Berlin Heidelberg. Zhang, Q., Huang, X. and Zhang, C., 2015. A mean-risk index model for uncertain capital budgeting.Journal of the Operational Research Society,66(5), pp.761-770.