Capital Budgeting and Sensitivity Analysis

This assignment delves into capital budgeting techniques applied to a project at Curtis Industries Ltd. Students are tasked with analyzing the Net Present Value (NPV) of the project under different scenarios, using sensitivity analysis to assess the impact of varying input factors like sales revenue and cost of sales. The analysis should also consider scenario planning for best, worst, and base case scenarios, evaluating the project's risk and ensuring its return aligns with the perceived risk level.

Running Head: Capital Investment Appraisal
Capital Budgeting

Capital Investment Appraisal 1
Question 1
Part 1)
Initial investment $ 2.40
Loan amount $ 1.20
Loan rate 5.70%
Loan instalment $ 0.28
Loan amortisation table:
Year
Openin
g
Instalmen
t Interest Principle
Closin
g
1
$
1.20
$
0.28
$
0.07
$
0.21
$
0.99
2
$
0.99
$
0.28
$
0.02
$
0.27
$
0.72
3
$
0.72
$
0.28
$
0.02
$
0.27
$
0.45
4
$
0.45
$
0.28
$
0.02
$
0.27
$
0.19
5
$
0.19
$
0.28
$
0.10
$
0.19
$
-
Total cost of
new equipment
$
2.40
Rate of
depreciation 40%
Depreciation
Year
Opening
Balance
Depreciatio
n
Closing
Balance
1 $ 2.40 $ 0.96 $ 1.44
2 $ 1.44 $ 0.58 $ 0.86
3 $ 0.86 $ 0.35 $ 0.52
4 $ 0.52 $ 0.21 $ 0.31
5 $ 0.31 $ 0.12 $ 0.19
Net present value
Year
Cash
flows
before
loan
paymen
t
Principl
e Interest
Net Cash
Flows
PVF@
12.5%
Present
Value

Capital Investment Appraisal 2
0
$ -
2.40
$
-2.40 1.000
$ -
2.40
1 $
1.04
$
0.21
$
0.07
$
0.76
0.889 $
0.67
2 $
0.60
$
0.27
$
0.02
$
0.32
0.790 $
0.25
3 $
0.97
$
0.27
$
0.02
$
0.68
0.702 $
0.48
4 $
0.55
$
0.27
$
0.02
$
0.27
0.624 $
0.17
5 $
0.70
$
0.19
$
0.10
$
0.42
0.555 $
0.23
5 $
0.24
$
-
$
-
$
0.24
0.555 $
0.13
NPV $ -
0.46
Net present value =$ -0.456 millions
Part 2)
Internal rate of return
IR
R
Year Cash flows
0 $ -2.40
1 $ 1.04
2 $ 0.60
3 $ 0.97
4 $ 0.55
5 $ 0.70
5 $ 0.24
IRR 21.34%
Internal rate of return= 21.34%
Part 3)
Payback period (years)
Yea
r Cash flows
Cumulative
Cash Flows
0 $ -2.40 $ -2.40
1 $ 1.04 $ -1.36
2 $ 0.60 $ -0.76
3 $ 0.97 $ 0.21
4 $ 0.55 $ 0.76

Capital Investment Appraisal 3
5 $ 0.70 $ 1.46
5 $ 0.24 $ 1.70
2.79
The Payback period of the company is 2.79 years
Part 4)
Accounting rate of return
ARR Average Net Profit
Average Investment
Year Cash flows
Depreciatio
n Interest
1 $ 1.04 $ 0.96 $ 0.07
$
0.01
2 $ 0.60 $ 0.58 $ 0.02
$
0.01
3 $ 0.97 $ 0.35 $ 0.02
$
0.60
4 $ 0.55 $ 0.21 $ 0.02
$
0.33
5 $ 0.70 $ 0.12 $ 0.10
$
0.48
Net profits
$
1.43
Average Net Profit $ 0.29
Average Investment 0.240+ 0.5(2.4-0.240)
$ 1.32
ARR 22%
Part 5)
Profitability Index
Profitability Index
Total present value of cash
flows
Initial investment
$ 1.94
$ 2.40
= 0.81

Capital Investment Appraisal 4
Part 6)
In this case the new contract
opportunity of capital investment is
evaluated on the basis of following
capital budgeting decision.
Net present value method:
Under this method the present values
of all the cash inflows and outflows are
calculated using the discounting rate of
12.5%. The aggregate of all the cash
inflows net of all the cash outflows is
the net present value.1 In this case, the
net present value of the new contract is
negative and it is recommended that
the project must not be accepted.
Internal Rate of return:
It is the discounting rate where the net
present value of the project is zero
which means the point where project
neither incurs any loss nor generates
any return. The internal rate of return
1 Karim Bennouna, Geoffrrey Meredith and Teresa Merchant, “Improved capital budgeting decision making: evidence from
Canada”, Management Decision 48(2010): 225-247.

Capital Investment Appraisal 5
of the new project is 21.34% which is
greater than the company’s required
rate of return i.e. 12.50%. Hence it can
be accepted.
Payback period:
It is the period taken by the project to
recover its initial investment. The
acceptable payback period of the
company is 2.5 years. However, the
payback period of the project is 2.79
years which is not acceptable. Hence
the project must not be accepted.
Accounting rate of return:
The company must make the
investment in the new contract
opportunity as its ARR i.e. 22% is
greater than the required rate of return
of 12.50%.
Profitability index:
Profitability index of more than 1 is
favourable. However, the profitability
index of the company is 0.81 which is
less than 1.2 Hence the project must not
2 Harold Bierman and Seymour Smidt: The Capital Budgeting Decision: Economic Analysis of Investment Projects

Capital Investment Appraisal 6
be accepted.
Overall decision:
Dukeview Corporations Ltd. must not
accept the new project opportunity as it
is not suitable and profitable for the
company from the viewpoint of various
capital investment appraisal techniques
such as Net present value, payback
period technique and the profitability
index. As these techniques are not
giving results in favour of accepting
the project.
(Routledge, 2007)

Capital Investment Appraisal 7
Question 2
Part 1
Years
Sales
$ -
95,15,000.00
Operating Expense
Administrative Expenses
Depreciation
Net Profit
$ -
95,15,000.00
Less: Tax
Cash flows after tax
$ -
95,15,000.00
Add: Depreciation
Free cash flows
$ -
95,15,000.00
Less: Working capital
investment
Net Cash Flows
$ -
95,15,000.00
PVF
$
1.00
PV of cash flows
$ -
95,15,000.00
NPV0
$
51,12,435.71

Capital Investment Appraisal 8
Part 2
Sales revenue sensitivity analysis can be done by changing two elements of sales figure i.e.
the sales units and sales price.
Following sensitivity analysis has been carried by changing both the elements by certain
percentages:
Table-1:Sales Units NPV
% Change Unit sales
$
51,12,435.71
5% 1,50,150.00 5718492.216
10% 1,57,300.00 6324548.722
15% 1,64,450.00 6930605.228
20% 1,71,600.00 7536661.734
25% 1,78,750.00 8142718.241
Base value 1,43,000.00 5112435.709
-5% 1,35,850.00 4506379.203
-10% 1,28,700.00 3900322.697
-15% 1,21,550.00 3294266.191
-20% 1,14,400.00 2688209.684
-25% 1,07,250.00 2082153.178
The above table shows that with every change of 5% in sales units the net present value of the
project will vary in the above manner.
Table-2: Unit
price NPV
% Change Unit price $51,12,435.71
5% $ 103.95 5718492.216
10% $ 108.90 6324548.722
15% $ 113.85 6930605.228
20% $ 118.80 7536661.734
25% $ 123.75 8142718.241
Base value $ 99.00 5112435.709
-5% $ 94.05 4506379.203

Capital Investment Appraisal 9
-10% $ 89.10 3900322.697
-15% $ 84.15 3294266.191
-20% $ 79.20 2688209.684
-25% $ 74.25 2082153.178
The above table shows that with every change of 5% in selling price per unit, the net present value
of the project will vary in the above manner.
Table-3: Cost of capital NPV
% Change Rate
$
51,12,435.71
5% 10.67% 5036033.517
10% 11.18% 5030905.366
15% 11.68% 5025745.757
20% 12.19% 5020554.582
25% 12.70% 5015331.732
Base value 10.16% 5041130.318
-5% 9.65% 5046195.876
-10% 9.14% 5051230.3
-15% 8.64% 5056233.698
-20% 8.13% 5061206.178
-25% 7.62% 5066147.848
The difference in the NPV is due to approximation.
Part 3
From the sensitivity analysis, only the change in one input parameter can be assessed at a
single time to check the sensitivity of net present value of the project. However, in scenario
analysis change in multiple inputs can be made to assess the impact of changes in complete
circumstances on the overall business plan.3 Scenario analysis helps the managers to
determine the net present values in the worst case, best case and in the base case. These
scenarios help the managers to assess the financial situation of the project if it faces the
unfavourable (worst) business environment situation or when it experiences the favourable
business environment situation.4 It also depicts the net present value in the scenario that is
3 William Cron and Thomas DeCarlo: Sales Management: Concepts and Cases (Wiley, 2010).
4 Michael Jensen, “Paying People to Lie: the Truth about the Budgeting Process”, European Financial Management 9(2003):
379-406.

Capital Investment Appraisal 10
most probable to happen i.e. in the normal business situations. Whereas, the sensitivity
analysis does not help managers in analysing these scenarios of the business.
Part 4
In the present case of Curtis Industries Ltd, the risk is priced into the project on the basis of
sensitivity analysis. Through the sensitivity analysis the risk is analysed by measuring the
extent to which the net present value of the project will change with the change in the various
factors. The return of the project of the capital investment is affected by various factors such
as investments, tax rate, revenue from sales and cost of sales.5 The overall net present value
of the project is positive hence it shows that net inflows are greater than the cash outflows
and hence it can be said that the return on the investment is in accordance with the risk.
5Andrea Saltelli, K. Chan, and E. M. Scott: Sensitivity Analysis (Wiley, 2000).

Capital Investment Appraisal 11
Bibliography
Bennounna, Karim, Geoffrrey Meredith and Teresa Merchant. “Improved capital budgeting decision
making: evidence from Canada”. Management Decision 48(2010): 225-247.
Bieerman, Harold and Seymour Smidt: The Capital Budgeting Decision: Economic Analysis of
Investment Projects (Routledge, 2007)
Cron, William and Thomas DeCarlo: Sales Management: Concepts and Cases (Wiley, 2010).
Jensen, Michael, “Paying People to Lie: the Truth about the Budgeting Process”, European Financial
Management 9(2003): 379-406.
Saltelli, Andrea, K. Chan, and E. M. Scott: Sensitivity Analysis (Wiley, 2000).