Capital Budgeting for New Investment Opportunity at Booli Electronics

Business Finance
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Contents
INTRODUCTION.................................................................................................................................3
FINANCIAL VIABILITY OF THE PROJECT....................................................................................4
Non-Discounted Pay-Back Period.....................................................................................................4
Profitability Index..............................................................................................................................4
Internal Rate of Return......................................................................................................................4
Net Present Value..............................................................................................................................4
SENSITIVITY ANALYSIS..................................................................................................................5
Change in sales price.........................................................................................................................5
Change in sales quantity....................................................................................................................5
EFFECT OF LOSS OF SALE OF OTHER MODELS DU%E TO NEW PROJECT............................7
CONCLUSION AND RECOMMENDATION.....................................................................................8
Bibliography........................................................................................................................................9
Appendix.............................................................................................................................................10
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INTRODUCTION
We have been provided with a new investment opportunity in which the company is required
to take decision, if it should proceed with such opportunity or not. Booli Electronics is a
company engaged in the business of manufacturing electronics. The company is seeking
advice on introduction of new product. They have conducted a market analysis which has
resulted in a collection of some financial data which might help us is taking the decision.
In order to evaluate the production opportunity, we have conducted capital budgeting for this
project. The results of this tool will help us to take the correct decision. (Seal, 2012) The
capita budgeting tool requires correct implementation and proper data in order to obtain the
appropriate result but we should always keep in mind the uncertainties that come with new
projects.
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FINANCIAL VIABILITY OF THE PROJECT
Non-Discounted Pay-Back Period
Pay- back period is a capital budgeting tool that helps us calculate the estimated time within
which the amount initially invested in the project will be recovered by the investors.
(Rivenbark, Vogt, & Marlowe, 2009) The cash by the company in time of the project
remaining after the pay- back period, will all be surplus. Therefore, lower the pay- back
period the better it is.
For the given opportunity the pay- back period is 2.02 years, whereas the project will be
carried on for 5 years. The pay- back period of the opportunity seems low.
Profitability Index
Profitability index is the ratio that calculated the cash inflow flow per unit of initial cash
outflow (Peterson & Fabozzi, 2012). Of the profitability index is more than one then it
indicates profits, if equal to one then it means that only invested amount will be recorded and
if less than one then it means that project will result in loss.
For the given project the profitability index is 1.71 time. The project will provide profits and
hence should be accepted.
Internal Rate of Return
Internal rate of return will calculate the exact return on the project (Noreen, 2015). This rate
is calculated by using the trial and error method on the expected cash inflows and outflows. If
the internal rate of return is more than required rate of return then the project should be
accepted.
The IRR for the given project results to be 37%. Therefore, the return on the investment is
sufficient and the project should be accepted.
Net Present Value
Net present value calculates the difference between the cash inflows and cash outflows which
are discounted using the required rate of return. (Menifield, 2014) If the net present value
results in positive balance the project should be accepted.
The net present value of the given project results to be $ 40.2 million approximately. Since
the project will result in positive NPV, it can be accepted.
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