COMM 132 - Small Group Discussion

FINANCIAL
INFORMATION FOR
BUSINES
STUDENT ID:
[Pick the date]

1) One risk could relate to increase in the cost capital for the project which would adversely
impact the viability of the proposed machine. In order to mitigate this risk, sensitivity
analysis ought to be considered to determine the underlying sensitivity of the key capital
budgeting techniques such as NPV to the changes in the cost of capital. This will provide
information to the management with regards to the extent of adverse cost of capital
movement that the project can withstand (Damodaran, 2015).
Another risk could relate to uncertainty regarding the future estimates of inflows if there is
any drastic change in the business environment which may not have been considered. In
order to incorporate the same, scenario analysis is a useful tool. In this, cash flow estimates
are worked out in the optimistic, base and pessimistic case along with highlighting the
underlying probabilities of occurrence of these scenarios. Then, based on the respective
probabilities of each scenario, a weighted NPV is worked out to see if this is positive or not
(Petty et. al., 2015).
2) The requisite cash flow time line is indicated as shown below.
3) Annual depreciation expense = (Initial Cost – Salvage Value)/Useful life
Based on the given information, initial cost of machinery = $ 106,250
Salvage value or residual value of the equipment at the end of the project = $15,000
Total useful life of the machinery =6 years
Hence, annual depreciation expense for the proposed machine = (106250-15000)/6 = $
15,208.33
4) The relevant formula for ARR is indicated below.

ARR = [(Total profit during the project useful life/Project Useful life)/Average
investment ]*100
In order to estimate the total profit during project useful life in context of the given machine,
the cumulative project cash flows table is indicated below.
From the above, total profit during project useful life = $ 25,650
Project Useful life = 6 years
Average investment = $ 106,250
Hence, ARR = [(25650/6)/106250]*100 = 4.02%
5) Payback period refers to the time required to recover the original investment (Parrino &
Kidwell, 2014). In order to estimate the payback period in context of the given machine, the
cumulative project cash flows table is indicated below.
From the above table, it is apparent that the cumulative project cash flows are negative in
year 4 and become positive in year 5, hence payback period would lie between 4 and 5 years.
Payback period = 4+ (5600/15625) = 4.358 years