Capital Budgeting - Assignment PDF

RUNNING HEAD: FINANCE
Capital budgeting

Finance 2
Contents
Introduction.................................................................................................................................................3
Requirement 1.............................................................................................................................................3
Requirement 2.............................................................................................................................................4
Requirement 3.............................................................................................................................................6
Requirement 4.............................................................................................................................................8
Requirement 5.............................................................................................................................................9
Requirement 6...........................................................................................................................................12
Requirement 7...........................................................................................................................................13
Conclusion and recommendation...............................................................................................................14
References.................................................................................................................................................15

Finance 3
Introduction
This report highlights the capital budgeting techniques used by Northern Lights Inc in order to
evaluate its new production line in efficient bulb markets. The most important method used in
the report is Net Present value method which determines the overall profitability of the project in
each and every scenario. In the later part, the report also focuses on the difference between
nominal and real cash flows, taking into account the nominal and real discounting rate. Further,
sensitivity analysis of the project has also been done in which the NPV of efficient bulb is tested
for different sales scenarios and inflation impact on production cost and selling price. Also, for
discounting rate of return the WACC of the company has been calculated and changes in the
same are shown in the later part of the report. In the end, a conclusion is provided that provide
insights about the profitability of the project to the company’s executives and VPs and help them
in taking decisions regarding making investment in the project.
Requirement 1
For the base case scenario, the total outflow made by the company is S545000. Considering the
impact of inflation at both the selling price and cost of production, the net present value of the
project is $ 73,103.77. This means that the project will be profitable in coming years as it has
high and positive NPV. Also, as per the decision criteria of this method, proposals having high
and positive net present value are considered to be profitable and favorable for the company
(Baker, Jabbouri and Dyaz, 2017).
Calculation of
NPV
Years 0 1 2 34
Cash flows - 163,874.40 200,296.98 169,940.58 278,785.38

Finance 4
545000
pvf@11% 1 0.9009009 0.811622430.73119138 0.658730974
Present values
-
545000 147634.595 162565.522 124259.089 183644.5663
NPV 73,103.77
Another method which is used to measure the viability of the project is payback period. It is the
simplest technique used as it determines the amount of time required by the proposal to recover
the initial investment or cash outlay (BiermanJr and Smidt, 2014). The payback period in case of
Northern Lights is 3 years which means out of the entire life of 4 years, the efficient bulb project
will take 3 years to recover the initial cash outflow of $545000 made by the company. However,
the method does not take into account the present values of cash flows.
Calculation of payback
period
Years 0 1 2 34
Cash flows
-
545000 163874.4 200296.98 169940.582 278785.3821
Cumulative cash flows
-
381125.6
-
180828.62
-
10888.0382 267897.3439
Payback period
3.0
4
Requirement 2
Real cash flows are the ones which do not consider the impact of inflation in their calculation
and are discounted at real required rate of return. On the other hand, nominal cash flows consider
the future amount of cash flows by taking into account the impact of inflation. It considers the
inflation in costs and revenue while calculating the cash flows and NPV of the project.