Project Evaluation and Capital Budgeting

This solved assignment delves into the crucial aspects of project evaluation and capital budgeting. It analyzes a hypothetical project's feasibility by applying various techniques such as Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, and Profitability Index. The analysis considers factors like cash flows, discount rates, and initial investment to determine the project's potential profitability and risk. Furthermore, the assignment touches upon the significance of capital structure decisions in influencing a firm's cost of capital and overall financial health.

ACCOUNTING AND FINANCE

TABLE OF CONTENTS
INTRODUCTION.......................................................................................................................................3
PART A.......................................................................................................................................................3
Necessity to consider ethics in the capital budgeting process..................................................................3
Part B...........................................................................................................................................................4
Debt and equity ratio or capital structure.................................................................................................4
Weighted average cost of capital.............................................................................................................4
3 Alternative capital structure to manage cost.........................................................................................5
Part C...........................................................................................................................................................5
(a)Payback period....................................................................................................................................5
(b)Discounted payback period.................................................................................................................6
© Net present value method....................................................................................................................6
(d)Profitability index...............................................................................................................................7
(e)Internal rate of return method..............................................................................................................8
(f) Proposal acceptance............................................................................................................................8
(g) Viability of project at 20% discount rate............................................................................................8
CONCLUSION...........................................................................................................................................8
REFERENCES............................................................................................................................................9

INTRODUCTION
Capital budgeting is the one of the most important technique that is used to select the
project. There are number of issues that are associated with the capital budgeting methods. In the
current report necessity to consider ethics in the capital budgeting process is explained in detail.
Along with this, in middle part of the report weighted average cost of capital is computed. At end
of the report cash budgeting method is used to evaluate the project and conclusion section is
prepared. In this way research is carried out.
PART A
Necessity to consider ethics in the capital budgeting process
There is a necessity to consider ethics in the capital budgeting process. In the capital
budgeting process first of all managers make projections about the cash flows. In this regard
number of factors is considered for making projection about the cash flows. There are number of
stakeholders of the business firm that are associated with the capital budgeting process. Usually
firms issue equity to finance their capital project. In the annual report lots of information is
provided about the prospective project (Bierman and Smidt, 2012. If the capital budgeting
process will not be implemented or performed in proper manner then wrong projections can be
made in respect to the project. Due to this reason it is possible that firm make investment in the
wrong project. If same will happened then investor will loose their money on investment. Thus,
it is very important for the business firm to follow all ethics while making projection in the
capital budgeting process. If accurate projection will be made then higher amount of return can
be given to the investor. In the capital budgeting process one has to make estimation about the
cash flows that may be observed in the upcoming time period. In order to make projection rate
estimation usually managers estimate the likely economic condition of the nation and likely
revenue that can be generated by the project due to project demand (Gervais, Heaton and
Odean, , 2011). Many times in order to obtain better results project managers use exaggerated
growth rate of cash flows to make projection. Due to this reason unviable project seems viable.
Thus, there is probability that wrong project will be selected. If same will happened then

investors will face heavy loss on investment. Due to this reason it is necessary to follow ethics in
the capital budgeting process.
Part B
Debt and equity ratio or capital structure
Current debt equity ratio of the business firm is 0.006. This means that there is very low
debt in the firm capital structure. It can be observed that firm equity is equal to 3.4 million and
debt is equivalent to 218586. It can be said that firm capital structure is balanced as there is very
low proportion of debt relative to equity in the capital structure.
Weighted average cost of capital
Table 1Computation of cost of capital
CAPM Assumptions
Ke 7.00%
RFR 3.0%
Beta 0.50
Rp 8%
Table 2Calcualtion of enterprise value
Enterprise
Value (EV)
Current Market
Price 0.031
Diluted Shares 109,677,419
Market
Capitalisation 3,400,000
Long Term
Liabilities 218,586
Less: Cash &

Cash Equivalents 261,678
Enterprise Value 3,356,908
Table 3Weighted average cost of capital
Debt Equity
Weightage
E/(D+E) @
Enterprise Value 93.96%
D/(D+E) @
Enterprise Value 6.04%
Interest Rate (%) 12%
Tax Rate (@) 30%
WACC
Calculation
WACC 7.08%
Weighted average cost of capital is 7.08% which means that cost of capital for the firm in its
business is 7.08%. In order to compute weighted average cost of capital weight of equity and
debt is computed. Cost is multiplied with weight to compute overall cost of capital.
3 Alternative capital structure to manage cost
In order to manage cost of capital alternative capital structure can be considered. It must
be noted that restructuring of capital can be done and under this buy back of shares can be done.
By doing so divided payment amount can be reduced in the business and cost of equity can be
controlled and overall finance cost can be reduced in the business.
Part C
(a)Payback period
Table 4Calculation of payback period
Project

Initial
investment -54200
1 20608 -33592
2 20608 -12984
3 20608 7624
4 20608 28232
5 33808 62040
Interpretation
Payback period reflects that project investment amount can be covered in the two years
and from the third year profit earning will be commenced out of five years. It can be said that
project is viable for the company.
(b)Discounted payback period
Table 5Disocunted payback period
Initial
investment
Project -54200
1 17920 -36280
2 15583 -20697
3 13550 -7147
4 11783 4635
5 16809 21444
Interpretation
Discounted payback period method under which present value of cash flows is computed
and then it is identified whether project is viable for the firm (Bennouna, Meredith and
Marchant, 2010). It can be observed from the table that investment can be covered in the three
year time period. This reflects that project is profitable for the business firm.
© Net present value method
Table 6 Calculation of net present value method
Project
PV @
15%
Present
value
Initial
investment 54200
1 20608 0.870 17920

2 20608 0.756 15583
3 20608 0.658 13550
4 20608 0.572 11783
5 33808 0.497 16809
Total 75644
NPV 21444
Interpretation
Net present value method reflects the value of the investment alternative after taken in to
account investment amount. It can be seen from the table given above that net present value of
the project is 21444. Value is positive and it can be said that project is viable for the firm.
(d)Profitability index
Table 7Profitability index
54200
1 17920
2 15583
3 13550
4 11783
5 16809
PV of cash
flows 75644
Initial
investment 54200
Profitability
index 1.3956447
Interpretation
Profitability index refers to the ratio under which sum value of present value of cash
flows is divided by the initial investment value. It can be observed that value of present value of
cash flows is 75644 and it is divided by initial investment value which is 54200. By doing so
profitability index is computed.

(e)Internal rate of return method
Table 8Calculation of internal rate of return
Project
Initial
investment -54200
1 20608
2 20608
3 20608
4 20608
5 33808
IRR 29.59%
Interpretation
Internal rate of return refers to the real rate of return that can be earned on the invested
amount. Results are reflecting that internal rate of return on project is 29.59% which means that
real rate of return on project is 29.59%. It can be said that project is viable for the firm.
(f) Proposal acceptance
Results are reflecting that project is viable for the firm because payback period is less and
net present value of the project is positive. Moreover, value of internal rate of return is moderate
and on this basis it is assumed that project is viable for the firm.
(g) Viability of project at 20% discount rate
Project at 20% discount rate cannot be viable for the firm because at high discount rate
value of cash flows declined. hence, project become less viable on NPV and IRR method.
CONCLUSION
On the basis of above discussion it is concluded that there is huge importance of project
evaluation method for the firms because same help it in making right decisions. Apart from this,
capital structure decisions must be taken in prudent manner by the business firm. This is because
same affects cost of capital. By working on alternative ways cost of capital can be reduced by the
firm in its business.

REFERENCES
Books and journals
Bennouna, K., Meredith, G.G. and Marchant, T., 2010. Improved capital budgeting decision
making: evidence from Canada. Management decision, 48(2), pp.225-247.
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge.
Gervais, S., Heaton, J.B. and Odean, T., 2011. Overconfidence, compensation contracts, and
capital budgeting. The Journal of Finance, 66(5), pp.1735-1777.