Capital Budgeting for KKP Ltd: A Financial Management Case Study

FINANCIAL MANAGEMENT
Table of Contents
Introduction......................................................................................................................................2
Findings & Recommendations........................................................................................................3
2.a) Quantitative..............................................................................................................................4
2.b) Qualitative................................................................................................................................8
Further Recommendations...............................................................................................................9
Conclusions....................................................................................................................................10
References......................................................................................................................................10

FINANCIAL MANAGEMENT
Introduction
Capital Budgeting is the method where a business determines and evaluates potential
expenses or investments which are large in nature. These are mainly concerned with investment
in a long-term venture or building of a new plant. The management has to use techniques of
capital budgeting for determination of that project which is going to yield most return over
applicable time period. Various methods that are included in capital budgeting are Net Present
Value (NPV), Internal Rate of Return (IRR) or Payback period.
KKP Ltd. Is in the business of automation. They are keen to launch in the food industry a
new type of proximity sensor. We will use capital budgeting tools to determine whether it is
feasible for KKP to invest in the proximity sensors.

FINANCIAL MANAGEMENT
Findings & Recommendations
They have already spent $75,000 on the research and to study the markets. This $75,000
spent is the sunk cost, which has no role play in the decision making for the firm as its already
spent and cannot be removed, we won’t be considering it in the cash flow.
The company has made an initial cash outflow that consists of $500,000 on building the
new machinery and working capital increment of $25,000 which the company will receive back
at the end of the time-period. This implies that our COF (Cash outflow) at the zero year will be
$(500,000+25,000) = $525,000.
This machine will be sold at the 5th year at a value of $220,000. The depreciation rate of
the machine based on the straight-line method is 10% i.e. 10% of $500,000 = $50,000 every year
for 5 years. The book value of the machine at the end of 5th year would be = $500000-(50000*5)
i.e. $250,000. The difference between the book value and the salvage value is going to be the
profit/loss of company. The Loss on machine would be $(220,000-250,000) = $30,0000. This
would be discounted at the 5th year to reach to the NPV of the machine.
The firm is having revenue of $50 per unit which comprises of variable cost of $30 per
unit. The contribution per unit is $30 for 5000 units i.e. $150,000. The company is having an
incremental cash flow of $80,000 in the form of reduced production costs every year. Also, there
is reduction in sales every year of $17,000. This will be adjusted to arrive at the revised
contribution. The fixed costs of $100,000, depreciation of $50,000 will be deducted from the
contribution getting us to the profit/loss before tax. Further tax would be reduced to arrive at
profit/loss after tax. To this we would add the depreciation and post-tax loss on sale and reach to
Cash Inflows of the company. The cash inflows must be discounted PVIF of 8% and from that