Online Jeans: Capital Budgeting Analysis of Investment Proposal

This project presents a capital budgeting analysis for an investment proposal by Online Jeans. The analysis includes three scenarios: base, worst, and best, each detailing cash inflows, outflows, and depreciation. The project calculates key financial metrics like Net Present Value (NPV), Profitability Index, and Payback Period for each scenario. It also discusses alternative capital budgeting approaches to account for risk, such as assigning probabilities to scenarios and adjusting the discount rate. Finally, the project evaluates whether the investment should be accepted, highlighting the need for additional information, such as the probability of each scenario, to make an informed decision. The project demonstrates how different scenarios impact the investment's viability and the importance of comprehensive financial analysis.

Part A – Solutions
a)Base Scenario
Year Year Year Year Year Year Year Year Year
Periods 0 1 2 3 4 5 6 7 8
Cash inflows
1,445,00
0 1,589,500 1,748,450
1,923,29
5 2,115,625
2,327,18
7
2,559,90
6
2,815,89
6
Plus cost of savings 0 0 0 0 0 0 0 0
Less costs
1,181,00
0 1,251,860 1,326,972
1,406,59
0 1,490,985
1,580,44
4
1,675,27
1
1,775,78
7
Less Depreciation Exp 206,250 206,250 206,250 206,250 206,250 206,250 206,250 206,250
Net Income before
tax 57,750 131,390 215,228 310,455 418,389 540,493 678,385 833,859
Less Income Tax 17,325 39,417 64,569 93,137 125,517 162,148 203,515 250,158
Net Income after Tax 40,425 91,973 150,660 217,319 292,872 378,345 474,869 583,701
Add Depreciation 206,250 206,250 206,250 206,250 206,250 206,250 206,250 206,250
After Tax Cash Flow 246,675 298,223 356,910 423,569 499,122 584,595 681,119 789,951
Initial project cost (1,650,000)
After Tax Terminal
Cash inflow 70,000
After Tax Cas Flow (1,650,000) 246,675 298,223 356,910 423,569 499,122 584,595 681,119 859,951
PBP 4.65
Discounted PBP 7.13
NPV 227,758
Profitability Index 1.13803
b)Worst Scenario
Year Year Year Year Year Year Year Year Year

Periods 0 1 2 3 4 5 6 7 8
Cash inflows
1,445,00
0
1,531,70
0 1,623,602
1,721,01
8 1,824,279 1,933,736 2,049,760 2,172,746
Plus cost of savings 0 0 0 0 0 0 0 0
Less costs
1,181,00
0
1,299,10
0 1,429,010
1,571,91
1 1,729,102 1,902,012 2,092,214 2,301,435
Less Depreciation Exp 206,250 206,250 206,250 206,250 206,250 206,250 206,250 206,250
Net Income before
tax 57,750 26,350 (11,658) (57,143) (111,073) (174,526) (248,703) (334,939)
Less Income Tax 17,325 7,905 (3,497) (17,143) (33,322) (52,358) (74,611) (100,482)
Net Income after Tax 40,425 18,445 (8,161) (40,000) (77,751) (122,168) (174,092) (234,457)
Add Depreciation 206,250 206,250 206,250 206,250 206,250 206,250 206,250 206,250
After Tax Cash Flow 246,675 224,695 198,089 166,250 128,499 84,082 32,158 (28,207)
Initial project cost (1,650,000)
After Tax Terminal Cash inflow 70,000
After Tax Cas Flow (1,650,000) 246,675 224,695 198,089 166,250 128,499 84,082 32,158 41,793
Cumulative CF (1,650,000) 246,675 471,370 669,459 835,709 964,208
1,048,29
0
1,080,44
8
1,122,24
0
PBP After 8 years
Discounted PBP After 8 years
NPV (931,822)
Profitability Index 0.43526
c)Best scenario
Year Year Year Year Year Year Year Year Year
Periods 0 1 2 3 4 5 6 7 8
Cash inflows 1,445,00 1,661,75 1,911,013 2,197,66 2,527,314 2,906,411 3,342,373 3,843,729

0 0 4
Plus cost of savings 0 0 0 0 0 0 0 0
Less costs
1,181,00
0
1,216,43
0 1,252,923
1,290,51
1 1,329,226 1,369,103 1,410,176 1,452,481
Less Depreciation Exp 206,250 206,250 206,250 206,250 206,250 206,250 206,250 206,250
Net Income before
tax 57,750 239,070 451,840 700,904 991,838 1,331,058 1,725,947 2,184,998
Less Income Tax 17,325 71,721 135,552 210,271 297,551 399,318 517,784 655,499
Net Income after Tax 40,425 167,349 316,288 490,633 694,287 931,741 1,208,163 1,529,498
Add Depreciation 206,250 206,250 206,250 206,250 206,250 206,250 206,250 206,250
After Tax Cash Flow 246,675 373,599 522,538 696,883 900,537 1,137,991 1,414,413 1,735,748
Initial project cost (1,650,000)
After Tax Terminal Cash inflow 70,000
After Tax Cas Flow (1,650,000) 246,675 373,599 522,538 696,883 900,537
1,137,99
1
1,414,41
3
1,805,74
8
PBP 3.73
Discounted PBP 5.02
NPV 1,507,043
Profitability Index 1.91336
2. Other capital budgeting approaches to allow for riskiness
 They can assign probabilities to assess the likelihood of each scenario. This will allocate an appropriate weight and
thus determine the expected Net present value of the project.
 The discount rate can be adjusted to allow for the riskiness in the cash flows, and then applied to the base scenario.
3. Discuss whether proposal should be accepted and any further information required to help make the
accept/reject decision

Each of the three scenarios has provided us with different acceptance/rejection rules. For example, we note under the
base and best case scenario, the organization should accept the new investment proposal given the NPV is positive,
Profitability Index is greater than 1 and the Payback period is less than 8. However, we note the converse under the worst
Case i.e. the company should reject the proposal given the NPV is negative, Profitability Index is less than 1 and the
Payback period is greater than the lifetime of project.
Thus Online Jeans cannot make an informed decision. Some additional information that may assist in making informed
decision on the proposal is if the company can provide the probability of each of the three scenarios to get the expected
NPV. For example, if the probability of the worst scenario was to be very high in comparison to base and best, then we
may end up rejecting the overall project.