Capital Budgeting Analysis

The assignment content discusses capital budgeting for a project that involves leasing out a plant to generate revenue. The calculations show that the net cash flow is negative, indicating that the project should not be accepted. Additionally, the profitability index and internal rate of return also suggest that the project is not feasible. A re-evaluation using the cost of equity at 13% further solidifies this conclusion.

Capital Budgeting

Table of Contents
Answer 1..........................................................................................................................................3
Answer 2..........................................................................................................................................6

Answer 1
In the given case we have taken the following assumptions:
 It is assumed that the depreciation on the plant will be applicable in all cases. Thus, the
same has been ignored for the purpose of calculating the net cash outflow.
 We have considered the opportunity cost for the lease out amount. The same has been
considered for the purpose of calculating the net cash inflow.
 Initial amount that has been spent on consultancy has been ignored being the same has
already been spent and cannot be rolled back if the project has not been accepted
1 2 3 4 5 P.V.
Inflow
Sales Units 390 390 390 390 390
Sales Price $
1,500
$
1,590
$
1,685
$
1,787
$
1,894
Variable Cost $
675
$
716
$
758
$
804
$
852
Contribution $
825
$
875
$
927
$
983
$
1,042
Contribution in value $
321,750
$
341,055
$
361,518
$
383,209
$
406,202
Fixed Cost $
70,000
$
71,400
$
72,828
$
74,285
$
75,770
Profit $
251,750
$
269,655
$
288,690
$
308,925
$
330,432
Less: Depreciation $
(138,000
)
$
(138,000
)
$
(138,000)
$
(138,000
)
$
(138,000
)
Less: Interest Cost on
Additional capital
$
(65,813)
$
(69,761)
$
(73,947)
$
(78,384)
$
(83,087)
Less: Opportunity Cost $
(112,125
)
$
(112,125
)
$
(112,125)
$
(112,125
)
$
(112,125
)
$
(64,188)
$
(50,231)
$
(35,382)
$
(19,584)
$
(2,780)
Less Tax $
17,973
$
14,065
$
9,907
$
5,483
$
778

$
(46,215)
$
(36,167)
$
(25,475)
$
(14,100)
$
(2,002)
Add: Depreciation $
138,000
$
138,000
$
138,000
$
138,000
$
138,000
Add: Salvage Value $
420,000
Total Cash Flow $
91,785
$
101,834
$
112,525
$
123,900
$
555,998
NPV @ 12% 0.89 0.80 0.71 0.64 0.57
$
81,951
$
81,181
$
80,093
$
78,740
$
315,488
$
637,45
4
Cash outflow $ 1,110,000
Cash Inflow $ 637,454
Net cash inflow $
(472,546)
Considering the net cash flow is negative, the same should not be
accepted.
Profitability Index
Cash inflow
1 $
81,951
2 $
81,181
3 $
80,093
4 $
78,740
5 $
315,488
$
637,454
$
1,110,000

Profitabilit
y Index
$
0.57
Internal Rate of return
Cash inflow
0 $ (1,110,000)
1 $ 81,951
2 $ 81,181
3 $ 80,093
4 $ 78,740
5 $ 315,488
IRR -13%
Payback period
 Being the cash inflow is lower than the cash outflow, the payback period concept will not
work.
Conclusion
All the figures or techniques utilized as part of capital budgeting approach are not showcasing
positive outcome, therefore the project should not be taken into account.

Answer 2
Capital asset pricing model
Cost of Equity = Risk-Free Rate + Beta * (Market Rate of Return - Risk-Free Rate)
Cost of Equity = 7% +1.5* (11%-7%)
Cost of Equity = 13%
In the above solution mentioned on the previous pages the calculations were done using the cost
of capital @ 12% still then the project is not found feasible to approach for. Now the evaluator
worked out the new rate as overall cost of investment, as 13 % which enhanced the investor’s
expectation. While witnessing the increase in the rate the cost of capital will further enhance the
approach for the deniability of the investment appraisal.

Bibliography
Course, M. A. (n.d.). Return on Capital Employed. Retrieved July 27, 2017, from My
Accounting Course: http://www.myaccountingcourse.com/financial-ratios/return-on-capital-
employed
Crom, F. d. (2011). Impact of capital structure choice on investment decisions. Retrieved Aug
16, 2017, from http://arno.uvt.nl/show.cgi?fid=129433
Salehi, M. (2009). Study of the Relationship between Capital Structure Measures and
Performance: Evidence from Iran. Retrieved Aug 16, 2017