Capital Budgeting Decision for New Equipment at Desklib

This article discusses the capital budgeting decision for new equipment at Desklib. The net cash flow, PV of cash inflow and outflow, and NPV of the project are calculated and analyzed. The recommendation is to reject the project due to negative NPV. The method of depreciation used is the straight-line method with the IRS convention of half-year convention.

Capital budgeting
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Information of new system
Information on New Equipment
Cost of New Equipment $1,000,000
Plus: Delivery and Installation $100,000
Plus: Immediate Net Working Capital Required for Asset $50,000
Net Investment $1,150,000
Calculation of net cash flow
Net Cash Flow
Calculation 0 1 2 3 4 5 6 7 8 9 10
A. Cash Inflows from
computer unit sales
(net) (Note 3 in sheet2)
200,
800
185,
960
171,
526
157,
456
143,
708
130,
224
116,
987
103,
923
91,0
27
78,2
22
B. Net Savings in cost
(Note 2 in sheet 2)
140,
000
136,
500
132,
755
128,
748
124,
460
119,
872
114,
963
109,
711
104,
091
98,0
77
2

C. Depreciation: (Note
1 in sheet 2)
78,5
71
157,
143
157,
143
157,
143
157,
143
157,
143
157,
143
78,5
71 - -
D. Incremental
Earnings Before Taxes
(A+B-C)
262,
229
165,
317
147,
138
129,
061
111,
025
92,9
53
74,8
07
135,
063
195,
117
176,
299
E. Taxes @ 35 %
91,7
80
57,8
61
51,4
98
45,1
71
38,8
59
32,5
34
26,1
83
47,2
72
68,2
91
61,7
05
F. Incremental Earnings
After Taxes (D-E)
170,
449
107,
456
95,6
40
83,8
90
72,1
66
60,4
20
48,6
25
87,7
91
126,
826
114,
594
G. Additional Net
Working Capital
(50,
000) - - - - - - - - -
H. After-tax Recapture
of Asset Salvage Value - - - - - - - - -
75,0
00
I. Recapture of
Working Capital - - - - - - - - -
75,0
00
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J. Net Cash Flow
$12
0,44
9
$10
7,45
6
$95,
640
$83,
890
$72,
166
$60,
420
$48,
625
$87,
791
$12
6,82
6
$26
4,59
4
PV factor @ 15%
0.86
96
0.75
62
0.65
76
0.57
18
0.49
72
0.43
24
0.37
6
0.32
7
0.28
43
0.24
72
PV of Cash flow
$10
4,74
2
$81,
258
$62,
893
$47,
968
$35,
881
$26,
125
$18,
283
$28,
708
$36,
057
$65,
408
Capital budgeting decision
Total PV of Cash Inflow $507,323
Total PV of Cash Outflow $1,150,000
NPV of Project ($642,677.13) Rejected since -ve NPV
Explanation of the answer and resulting recommendation
The First Republic Bancorp should reject the project as NPV of the project is negative
$642677.13 which indicates that the investment won’t be profitable for the company.
The method of deprecation used for the case is straight line method and IRS convention is half
year convention.
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Working notes
Calculation of net savings
1 2 3 4 5 6 7 8 9 10
Saving
s
190,00
0
190,00
0
190,00
0
190,00
0
190,00
0
190,00
0
190,00
0
190,00
0
190,00
0
190,00
0
Cost
for
saving
s with
7%
increa
se 50,000 53,500 57,245 61,252 65,540 70,128 75,037 80,289 85,909 91,923
Net
Saving
s
140,00
0
136,50
0
132,75
5
128,74
8
124,46
0
119,87
2
114,96
3
109,71
1
104,09
1 98,077
Calculation of revenue from additional unit sold
Calculation of
revenue from
additional
unit sold
20000 200 14
5

Qty demanded for 1st
year
as per demand function 17200
1 2 3 4 5 6 7 8 9 10
No. of additional
computer time sold
with 5 % decline
every year
17,20
0
16,34
0
15,52
3
14,74
7
14,01
0
13,30
9
12,64
4
12,01
1
11,41
1
10,84
0
Rounded off units
17,20
0
16,34
0
15,52
3
14,74
7
14,01
0
13,30
9
12,64
4
12,01
1
11,41
1
10,84
0
Price 14 14 14 14 14 14 14 14 14 14
Sales revenue of
unit
240,8
00
228,7
60
217,3
22
206,4
58
196,1
40
186,3
26
177,0
16
168,1
54
159,7
54
151,7
60
Cost in selling
computer time
40,00
0
42,80
0
45,79
6
49,00
2
52,43
2
56,10
2
60,02
9
64,23
1
68,72
7
73,53
8
Net revenue from
computer time unit
sale
200,8
00
185,9
60
171,5
26
157,4
56
143,7
08
130,2
24
116,9
87
103,9
23
91,02
7
78,22
2
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References
Götze, U., Northcott, D. and Schuster, P., 2015. Capital Budgeting and Investment Decisions. In
Investment Appraisal (pp. 3-26). Springer, Berlin, Heidelberg.
Sari, I.U. and Kahraman, C., 2015. Interval type-2 fuzzy capital budgeting. International Journal
of Fuzzy Systems, 17(4), pp.635-646.
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