Replacement Decisions under Capital Budgeting

This report analyzes the replacement decision of Safa Motors Ltd. to replace its old plant with a new one that produces electrical vehicles. The report applies various capital budgeting techniques such as NPV, IRR, ARR and Payback Period to evaluate the decision. The report also includes a sensitivity analysis and a critical analysis of capital budgeting techniques. Subject: Finance, Course Code: FIN101, College/University: Not mentioned.

Running Head: Capital Budgeting Decision Making
REPLACEMENT DECISIONS UNDER CAPITAL BUDGETING

Capital Budgeting Decision Making 1
Executive summary:
Safa Motors Ltd. is the company that is engaged in the business of manufacturing of vehicles.
Currently the company is manufacturing only petrol and diesel vehicles. However, after the
occurrence of Volkswagen Scandal, the company has started considering the proposal of
replacing its manufacturing its old plant with the new plant that produces the electrical vehicles
in place of petrol and diesel vehicles. This decision is being proposed in order to meet the
environmental laws and regulation of the country. To replace the old plant with a new one, the
different capital budgeting techniques have been applied in the report such as payback period,
net present value analysis, sensitivity analysis to estimate the worth of replacement decision.

Capital Budgeting Decision Making 2
Table of Contents
Executive summary:....................................................................................................................................1
Introduction:...............................................................................................................................................4
Relevant and Non-Relevant Costs of the proposed project:........................................................................4
The total cash flows and the profits for the next five years:.......................................................................5
Total incremental (net) profits and cash flows:...........................................................................................6
Cost Volume Profit Analysis:........................................................................................................................7
Application of various capital budgeting techniques...................................................................................8
Sensitivity Analysis:.....................................................................................................................................8
Change in sales volume...........................................................................................................................9
Change in selling price.............................................................................................................................9
Change in required rate of return............................................................................................................9
Change in useful life of project................................................................................................................9
Critical analysis of capital budgeting techniques:......................................................................................10
Payback period:.....................................................................................................................................10
Net present value:.................................................................................................................................11
Accounting rate of return:.....................................................................................................................12
Internal rate of return:..........................................................................................................................13
Non-financial factors of Replacement Decision:........................................................................................14
Conclusion:................................................................................................................................................15
References:................................................................................................................................................16
Appendices................................................................................................................................................19
Appendix 1: Forecasted total cash flows and total profits:....................................................................19
Appendix 2: Forecasted net cash flows and profits:..............................................................................23
Appendix 3: CVP Analysis.......................................................................................................................24
Appendix 4: Capital investment appraisal:............................................................................................25
Appendix 5: Sensitivity Analysis.............................................................................................................27

Capital Budgeting Decision Making 3

Capital Budgeting Decision Making 4
Introduction:
This report is being prepared to analyze the decision of Safa Motors Ltd in regards to the
replacement of old plant and equipment that is currently being used in the manufacturing of
petrol and diesel cars with the new plant that will manufacture the electrical vehicles. If the new
plant is implemented then the production of petrol and diesel car be abandoned and hence the old
plant and equipment will run out of use and hence it will be disposed in the market and funds
from it will be used to acquire the new machine that is more technical in nature. Since the
investment in new plant requires huge amount of funds, such replacement decision must be
carefully evaluated by applying various techniques of capital budgeting such as net present value
analysis, payback period analysis, sensitivity analysis .etc. The incremental cash flows approach
has been used to evaluate the replacement decision.
Relevant and Non-Relevant Costs of the proposed project:
While determining the worthiness of any project, the project manager has to undertake the cost
benefit analysis of the project under which all the costs and benefits of the project are separately
and jointly considered to understand their impact on the overall value of the project. Primarily,
the cost is divided into two categories i.e. the relevant cost and irrelevant cost. Relevant costs are
those costs that are useful to be given consideration while taking the decisions about project’s
acceptance or rejection. However relevant costs are those costs that do not affect the further cash
flows of the project and are the common part of all the alternative projects under considerations.
These costs are either sunk costs that have already been incurred or the costs that forms part in
all the alternative options of investment.

Capital Budgeting Decision Making 5
In the present case, the cost of research carried for the diesel and petrol cars is a sunk cost as it
has already been incurred and hence it cannot be recovered under any circumstance. Therefore
this cost of £250000 is irrelevant in nature and thus it must be ignored while making the
evaluation of equipment decision. Further, the cost of acquisition of old equipment used to
manufacture the petrol and diesel cars is not to be taken into consideration while making the
calculation of incremental initial investment as it has already been incurred. But, the same must
be considered to calculate the depreciation on the equipment. However, the depreciation expense
on both the equipment is also irrelevant in nature since the present question has asked to ignore
the tax impact of the cash flows and hence the depreciation is not relevant to be considered in
such as it does not amount to flow of cash (Chen, 2008). The relevant costs of the replacement
decision under consideration are all other costs that are taken into consideration while calculating
the net present value of the project. These costs are: Cost of acquisition of new investment,
material cost, labor cost, variable cost, fixed cost such as research and development cost, selling ,
savings in the cost of components of old car, increase in the cost of new components.
The total cash flows and the profits for the next five years:
The total cash flows and the profits for the next five years under both the projects i.e.
manufacturing the old cars only and the new cars only are shown in the tables below:
Refer Appendix 1:
Old car:
Year 1 2 3 4 5
Profit £ £ £ £ £

Capital Budgeting Decision Making 6
36,470,000.00 36,470,000.00 36,470,000.00 36,470,000.00 36,470,000.00
Year 0 1 2 3 4 5
Free
Cash
Flows
£
-
£
37,750,000.00
£
37,750,000.00
£
37,750,000.0
0
£
37,750,000
.00
£
37,800,000.
00
New car:
Year 0 1 2 3 4 5
Profi
t
-£
9,996,50
0.00
£
17,575,262
.00
£
35,970,262
.00
£
43,212,112.0
0
£
50,818,217.50
£
58,806,856.17
Year 0 1 2 3 4 5
Free
Cash
Flow
s
-£
9,996,50
0.00
£
19,414,562.0
0
£
37,809,562.0
0
£
45,051,412.0
0
£
52,657,517.5
0
£
61,446,156.1
7
Total incremental (net) profits and cash flows:
Refer Appendix 2

Capital Budgeting Decision Making 7
Year 0 1 2 3 4 5
Increment
al Profit
-£
18,894,
738.00
-£
499,738.00
£
6,742,112.00
£
14,348,217.5
0
£
22,336,856.1
7
Total incremental cash flows:
Year 0 1 2 3 4 5
Incremental
Cash Flows
-£
9,046,500.
00
-£
18,335,438.
00
£
59,562.00
£
7,301,412.
00
£
14,907,5
17.50
£
23,646,
156.17
The cash flows under new project are accounted for by taking into consideration the savings in
the component cost of old machinery and increase in the component cost of new machinery on
the assumption that such savings and costs will take place in each year.
Cost Volume Profit Analysis:
Further, the cost volume analysis is undertaken to determine the impact of cost and volume
factor of the outcomes on the overall profitability of the project. Breakeven analysis is the
analysis under which, sales at the point at which the company does not incur any loss or earn any
profit, is calculated. It is the point at which the project is able to cover all its cost with the
revenues. The sales quantum beyond the breakeven point is called as margin of safety. From the
CVP analysis, it has been found that, in order to reach at the point where the company incurs no

Capital Budgeting Decision Making 8
loss and earns no profit, it is required to sell 43723 units of new electric vehicles and after this
point it will start earning profits (Refer Appendix 3).
Application of various capital budgeting techniques:
Further in the report various techniques of capital budgeting are applied to evaluate the
replacement decision. For this purpose, NPV, IRR, ARR and Payback Period are calculated. The
NPV of the replacement decision is positive and hence it indicates that it will be profitable to
accept the decision of manufacturing the electric vehicles only in place of diesel cars. However,
the desirable payback period of the project is 3.5 years while the calculations have shown that
the old machinery replacement will result in the payback period of around 4.34 years which is
higher than the desirable period of time (Refer Appendix 4). Therefore, it is necessary to identify
the objective of company behind such investment. If the company is expecting to earn maximum
returns within the minimum time then it must not accept the proposed project. But, if the main
aim of the project is to earn maximum returns irrespective of the time period it must accept the
new plant implementation project as the calculation of Annual rate of return is found to be quite
higher (85%) than the desirable results (35%). Further, the internal rate of return of the project is
15.17% and it is higher than the cost of capital of the project (12%). It signifies that the project
has higher return potential. Therefore it must be accepted.
Sensitivity Analysis:

Capital Budgeting Decision Making 9
Further, the sensitivity analysis is applied to understand the project’s sensitivity in terms of NPV
is undertaken using various variables (Graham & Harvey, 2002).The impact of change in such
variables on the overall NPV of the project is analyzed as below:
(Refer Appendix 5)
Change in sales volume
Increase in sales units by 10% £ 325,452,353.62
Decrease in sales units by 10% £ 145,522,441.60
Change in selling price
Increase in Selling Price by 10% £ 570,244,836.75
Decrease in Selling Price by 10% -£ 466,790,151.65
Change in required rate of return
Increase in Required rate of return by 2% £ 27,346.68
Decrease in Required rate of return by 2% £ 3,765,287.37
Change in useful life of project
Increase in years in useful life by 1 year £ 37,178,243.96
Decrease in years in useful life by 1 year -£ 11,648,946.61

Capital Budgeting Decision Making 10
Critical analysis of capital budgeting techniques:
Each technique of investment appraisal has some of its strengths and also each of these
techniques suffers from limitations that are discussed below:
Payback period:
The payback period technique of capital budgeting is used to determine the time that the project
will take to recover funds invested in the project. It is basically the break-even point of the
investment. The project that has the potential to recoup its cost of investment in minimum time is
acceptable. The technique of pay- back period has its own strengths and limitations which are as
follows:
Strengths:
 The determination of payback period is comparatively easier than other techniques of
capital budgeting and hence it can conveniently be applied to the project.
 It is most significant for the firms that have limited resources as it determines the project
that is capable of generating returns quickly. Payback period is the most appropriate
technique for the projects that have low investment budget.
 Payback period helps the project manager to identify the risk of the project even before
the commencement of the same by indicating the time within which the project will
recoup the project cost.
 This technique is also best suitable to the industries where there are trends of technical
obsolesce because of the short spans of such projects (Baker & English, 2011).
Limitations:

Capital Budgeting Decision Making 11
 The technique of payback period does not consider the time value of money and it counts
as the significant weakness of this technique.
 Moreover, payback period takes into consideration the annual cash flows and not the net
income of the project. The consideration of net profits offers more realistic results than
the cash flows of the project and due to this reason, the realistic results are not offered by
payback period.
 Also, the terminal value of the project is also considered in the payback technique.
 The cash flows that are supposed to be generated after the payback period are not
considered under payback technique and therefore it fails to take the overall view of the
project’s riskiness.
Net present value:
The net present value technique of the project is the most common technique of capital
budgeting. It involves determination of the overall worth of the project on the basis of total
present value of net cash flows of the project (Hall & Millard, 2010). Under this technique, all
the inflows and outflows of project are considered and then the net impact of such cash flows is
calculated to determine whether the project has the potential to generate returns or it will result in
net cash outflows. Advantages:
 The key strength of the project is that it considers the cash flows of the project over the
entire useful life of the project.
 Further, the technique of net present value gives regards to the time value of money and
hence it gives more realistic picture of project returns and risks.

Capital Budgeting Decision Making 12
 The interpretation of the results of net present value technique is easier to be understood
than the results of other techniques.
Limitations:
 The calculation of net present values of the project requires the determination of required
rate of return i.e. the cost of capital so as to calculate the present values of the cash flows.
 The projects with different life spans are tough to be evaluated under this technique as the
comparison is not possible (Kahraman, 2001).
Accounting rate of return:
ARR is the only technique of capital budgeting that uses the net profits to determine the
financial feasibility of the project and not the cash flows associated with the project. Each project
has its own pre determined cut off rate and if the ARR of such project is higher than the cut off
rate then it is acceptable because it has the ability to generate returns (Ryan & Ryan, 2002). The
key strengths and limitations of accounting rate of returns are:
Advantages:
 This technique involves convenient approach of determining the project’s worth.
 As the net profitability of the project is considered to evaluate its worthiness under ARR
method, the results of it are more sophisticated in nature (Peterson & Fabozzi, 2002).
Limitations:
 The time value of money is not considered under ARR technique also and hence the
results of this technique are not accurate enough.

Capital Budgeting Decision Making 13
 It also ignores the reduction in the value of original investment in the way it charges
depreciation against the profits reported by it. The theory of recovery of capital over a
time period is ignored under ARR (Borgonovo, 2017).
 Further the application of ARR is irrelevant under the situations where capital investment
is not undertaken at the commencement stage of project.
Internal rate of return:
It is the rate at which there does not arise any profits and loss under the project and hence the
NPV of the project is zero at the IRR point. The reason why there is no profit or loss at this point
is that the present value of cash inflows is equals to the present value of cash outflows (Baker,
Jabbouri & Dyaz, 2017). The strengths and limitations of IRR technique are discussed below:
Advantages:
 The importance of time value of money is given due consideration under IRR technique.
 All the cash flows of the project are taken into account under this method and hence it
offers more reliable results.
 The objective of wealth maximization of the owner is met under IRR method of capital
budgeting analysis (Verbeeten, 2006).
Limitations:
 The final outcomes of this technique are complex in nature and hence not easily
understandable.
 IRR involves the application of hit and trial method to reach at the final internal rate of
return (Truong, Partington & Peat, 2008).

Capital Budgeting Decision Making 14
All the above techniques that are discussed above are used to determine the financial
feasibility of the project but in order to accept the replacement decision, it is also necessary to
consider non financial factors of the proposed project.
Non-financial factors of Replacement Decision:
The non-financial factors are those factors that would not be affecting the project’s performance
in monetary value but will influence the decision of the project manager (Bennouna, Meredith &
Marchant, 2010). These factors are:
 Competition and Market Structure:
Before deciding on the replacement of the old vehicle manufacturing machines with the new
machines it is necessary to identify the major competitive forces of the industry so as to decide
whether the proposed project will result in creation of monopoly, oligopoly or monopolistic
competition market structure in the country.
 Technology, labor and raw material availability:
The manufacturing of new electric vehicles will require deployment of advanced technology and
highly skilled labor force. Also, whether the raw material required for producing the electric cars
will be available in the domestic market or it will be required to import from different countries.
Therefore, it is necessary to consider the availability of such requisites of new manufacturing
unit in the market before taking up the replacement decision.
 Environmental impact:

Capital Budgeting Decision Making 15
Before replacing the old vehicle manufacturing plant and equipment it must be ensured that the
proposed new manufacturing plant and equipment will meet the environmental regulations and
standards of the country as one of the major reasons behind the decline in the demands of diesel
and petrol vehicles is the emission of toxic elements from such vehicles in the environment that
causes heavy pollution.
 Specific features of electric cars:
Since the electric vehicles requires the electric charging that involves considerable time therefore
the people will not adopt the change in the technology easily and this factor will affect the
replacement decision to a material extent.
Conclusion:
From the overall financial analysis, it has been found that the project of replacing the old vehicle
manufacturing car with the new plant that produces electric vehicles is quite sensitive in nature
to various input variables and hence all such variables must be taken into due consideration
before reaching the final solution. Further, it is also important for Safa Motors Ltd. to consider
the non-financial factors also that are associated with the replacement decision. The application
of capital budgeting techniques has shown that the proposed replacement project will take more
substantial period of time to cover the initial costs of investment and hence it is recommended
that the company must continue with the manufacturing of diesel cars. However, if the firm has
an objective of maximum return generation then it must accept the new machinery investment
decision as it will entail positive NPV and higher ARR than the expected results.

Capital Budgeting Decision Making 16
References:
Baker, H.K. and English, P., 2011. Capital budgeting valuation: Financial analysis for today's
investment projects (Vol. 13). John Wiley & Sons.
Baker, H.K., Jabbouri, I. and Dyaz, C. (2017). Corporate finance practices in
Morocco. Managerial Finance, 43(8), 865-880.
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. (2014) Advanced capital budgeting: Refinements in the economic
analysis of investment projects. Oxon: Routledge.
Borgonovo, E. (2017). Sensitivity Analysis: An Introduction for the Management Scientist (Vol.
251). Switzerland: Springer.
Brigham, E. F., & Houston, J. F. (2012). Fundamentals of financial management. Cengage
Learning.
Brijlal, P., 2008. The use of capital budgeting techniques in businesses: A perspective from the
Western Cape. Available at: <
http://repository.uwc.ac.za/bitstream/handle/10566/3786/Brijlal_The-use-of-capital_2009.pdf?
sequence=1&isAllowed=y>v Accessed on: 27.7.2018
Chen, S., 2008. DCF techniques and nonfinancial measures in capital budgeting: a contingency
approach analysis. Behavioral Research in Accounting, 20(1), pp.13-29.

Capital Budgeting Decision Making 17
Daunfeldt, S.O. and Hartwig, F. (2014). What determines the use of capital budgeting methods?:
Evidence from Swedish listed companies. Journal of Finance and Economics, 2(4),101-112.
Dayananda, D., Harrison, S., Irons, R., Herbohn, J. and Rowland, P., 2002. Capital budgeting:
financial appraisal of investment projects. Cambridge University Press.
Drake, (n.d.) Capital Budgeting Decisions. Available on: <
http://educ.jmu.edu/~drakepp/principles/module6/capbudtech.pdf> Accessed on: 27.07.2018.
Graham, J. and Harvey, C., 2002. How do CFOs make capital budgeting and capital structure
decisions?. Journal of applied corporate finance, 15(1), pp.8-23.
Hall, J. and Millard, S., 2010. Capital budgeting practices used by selected listed South African
firms. South African Journal of Economic and Management Sciences, 13(1), pp.85-97.
Kahraman, C., 2001. Capital budgeting techniques using discounted fuzzy cash flows. In Soft
Computing for Risk Evaluation and Management (pp. 375-396). Physica, Heidelberg.
Peterson, P.P. and Fabozzi, F.J., 2002. Capital budgeting: theory and practice (Vol. 10). John
Wiley & Sons.
Ryan, P.A. and Ryan, G.P., 2002. Capital budgeting practices of the Fortune 1000: how have
things changed. Journal of business and management, 8(4), pp.355-364.
Truong, G., Partington, G. and Peat, M., 2008. Cost-of-capital estimation and capital-budgeting
practice in Australia. Australian journal of management, 33(1), pp.95-121.

Capital Budgeting Decision Making 18
Verbeeten, F.H., 2006. Do organizations adopt sophisticated capital budgeting practices to deal
with uncertainty in the investment decision?: A research note. Management accounting
research, 17(1), pp.106-120.

Capital Budgeting Decision Making 19
Appendices
Appendix 1: Forecasted total cash flows and total profits:
If old machine is continued:
Petrol and Diesel 2019 2020 2021 2022 2023
Initial Investment
Sales Volume 75000 75000 75000 75000 75000
Selling Price
£
8,500.00
£
8,500.00
£
8,500.00
£
8,500.00
£
8,500.00
Sales
£
637,500,000
.00
£
637,500,000
.00
£
637,500,000
.00
£
637,500,000
.00
£
637,500,000
.00
Material Cost
£
352,500,000
.00
£
352,500,000
.00
£
352,500,000
.00
£
352,500,000
.00
£
352,500,000
.00
Labor Cost
£
75,000,000.
00
£
75,000,000.
00
£
75,000,000.
00
£
75,000,000.
00
£
75,000,000.
00
Variable Overhead
£
86,250,000.
00
£
86,250,000.
00
£
86,250,000.
00
£
86,250,000.
00
£
86,250,000.
00
Total Variable Cost £ £ £ £ £

Capital Budgeting Decision Making 20
513,750,000
.00
513,750,000
.00
513,750,000
.00
513,750,000
.00
513,750,000
.00
Contribution
£
123,750,000
.00
£
123,750,000
.00
£
123,750,000
.00
£
123,750,000
.00
£
123,750,000
.00
Fixed Cost
Selling Expenses
£
63,750,000.
00
£
63,750,000.
00
£
63,750,000.
00
£
63,750,000.
00
£
63,750,000.
00
Administrative
Expenses
£
20,500,000.
00
£
20,500,000.
00
£
20,500,000.
00
£
20,500,000.
00
£
20,500,000.
00
Depreciation
£
1,280,000.0
0
£
1,280,000.0
0
£
1,280,000.0
0
£
1,280,000.0
0
£
1,280,000.0
0
Research and
Development Cost
£
1,750,000.0
0
£
1,750,000.0
0
£
1,750,000.0
0
£
1,750,000.0
0
£
1,750,000.0
0
Total Fixed Cost
£
87,280,000.
00
£
87,280,000.
00
£
87,280,000.
00
£
87,280,000.
00
£
87,280,000.
00
Profit £
36,470,000.
£
36,470,000.
£
36,470,000.
£
36,470,000.
£
36,470,000.

Capital Budgeting Decision Making 21
00 00 00 00 00
Add Depreciation
£
1,280,000.0
0
£
1,280,000.0
0
£
1,280,000.0
0
£
1,280,000.0
0
£
1,280,000.0
0
Free Cash Flows
£
37,750,000.
00
£
37,750,000.
00
£
37,750,000.
00
£
37,750,000.
00
£
37,800,000.
00
If old machine is replaced with new machine:
Electric Vehicle 2019 2020 2021 2022 2023
Initial Investment
Sales Volume 50000 52500 55125 57881 60775
Selling Price
£
14,000.00
£
14,000.00
£
14,000.00
£
14,000.00
£
14,000.00
Sales
£
700,000,00
0.00
£
735,000,000.00
£
771,750,00
0.00
£
810,337,50
0.00
£
850,854,3
75.00
Material Cost
£
375,000,00
0.00
£
393,750,000.00
£
413,437,50
0.00
£
434,109,37
5.00
£
455,814,8
43.75

Capital Budgeting Decision Making 22
Labor Cost
£
75,000,000.
00
£
78,750,000.00
£
82,687,500.
00
£
86,821,875.
00
£
91,162,96
8.75
Variable Overhead
£
110,000,00
0.00
£
115,500,000.00
£
121,275,00
0.00
£
127,338,75
0.00
£
133,705,6
87.50
Total Variable Cost
£
560,000,00
0.00
£
588,000,000.00
£
617,400,00
0.00
£
648,270,00
0.00
£
680,683,5
00.00
Contribution
£
140,000,00
0.00
£
147,000,000.00
£
154,350,00
0.00
£
162,067,50
0.00
£
170,170,8
75.00
Fixed Cost
Selling Expenses
£
85,085,438.
00
£
85,085,438.00
£
85,085,438.
00
£
85,085,438.
00
£
85,085,43
8.00
Administrative
Expenses
£
20,500,000.
00
£
20,500,000.00
£
20,500,000.
00
£
20,500,000.
00
£
20,500,00
0.00
Depreciation
£
1,839,300.0
0
£
1,839,300.00
£
1,839,300.0
0
£
1,839,300.0
0
£
1,839,300.
00
Research and
Development Cost
£
3,500,000.
£
3,605,000.
£
3,713,150.0
£
3,824,544.5
£

Capital Budgeting Decision Making 23
00 00 0 0 3,939,280.84
Increase in new car
component cost
£
14,500,00
0.00
£
14,500,000
.00
£
14,500,000.
00
£
14,500,000.
00
£
14,500,000.00
Decrease in old car
component
-£
3,000,000.
00
-£
3,000,000.
00
-£
3,000,000.0
0
-£
3,000,000.0
0
-£
3,000,000.00
Total Fixed Cost
£
122,424,7
38.00
£
111,029,73
8.00
£
111,137,88
8.00
£
111,249,28
2.50
£
111,364,018.84
Profit
£
17,575,26
2.00
£
35,970,262
.00
£
43,212,112.
00
£
50,818,217.
50
£
58,806,856.17
Add Depreciation
£
1,839,300.
00
£
1,839,300.
00
£
1,839,300.0
0
£
1,839,300.0
0
£
1,839,300.00
Free Cash Flows
£
19,414,56
2.00
£
37,809,562
.00
£
45,051,412.
00
£
52,657,517.
50
£
61,446,156.17
Appendix 2: Forecasted net cash flows and profits:
Year 1 2 3 4 5

Capital Budgeting Decision Making 24
Incremental
Profit
-£
18,894,738.00
-£
499,738.00
£
6,742,11
2.00
£
14,348,217
.50
£
22,336,
856.17
Years 0 1 2 3 4 5
Cash flows
from new
equipment
-£
9,996,500.0
0
£
19,414,562.00
£
37,809,562
.00
£
45,051,4
12.00
£
52,657,517
.50
£
61,446,
156.17
Less: Cash
flows from old
equipment
(Inflow)
£
950,000.00
£
37,750,000.00
£
37,750,000
.00
£
37,750,0
00.00
£
37,750,000
.00
£
37,800,
000.00
Incremental
Cash Flows
-£
9,046,500.0
0
-£
18,335,438.00
£
59,562.00
£
7,301,41
2.00
£
14,907,517
.50
£
23,646,
156.17
Appendix 3: CVP Analysis
Old Equipment Formula 2019
Total Fixed Cost £ 87,280,000.00
Contribution per unit £ 1,650.00

Capital Budgeting Decision Making 25
Breakeven Units
Contribution per unit = Total
Contribution/No. of Units 52897
Margin of Safety Total Sales- Margin of Safety 22103
New Equipment Formula
Breakeven Point Total Fixed Cost £ 122,424,738.00
Contribution per unit £ 2,800.00
Breakeven Units
Contribution per unit = Total
Contribution/No. of Units 43723
Margin of Safety Total Sales- Margin of Safety 6277
Appendix 4: Capital investment appraisal:
NPV
Calculations
Year 0 1 2 3 4 5
Incremental
Cash Flows
-£
9,046,500.0
0
-£
18,335,438.00
£
59,562.00
£
7,301,41
2.00
£
14,907,51
7.50
£
23,646,1
56.17
DCF @ 12% 1.000 0.893 0.797 0.712 0.636 0.567

Capital Budgeting Decision Making 26
Present Value
of Cash Flows
-£
9,046,500.0
00
-£
16,370,926.78
6
£
47,482.46
2
£
5,197,00
0.843
£
9,473,996.
875
£
13,417,4
64.043
NPV
£
2,718,517.4
37
Payback
Period
Calculations
Year 0 1 2 3 4 5
Payback
Period
-£
9,046,500.0
0
-£
18,335,438.00
£
59,562.00
£
7,301,41
2.00
£
14,907,51
7.50
£
23,646,1
56.17
-£
9,046,500.0
0
-£
27,381,938.00
-£
27,322,37
6.00
-£
20,020,9
64.00
-£
5,113,446.
50
£
18,532,7
09.67
Payback
Period Years 4.34 years
Annual Rate
of Return
Calculations

Capital Budgeting Decision Making 27
ARR
Average
Income
£
4,806,541.93 85%
Average
Investment
£
5,648,250.00
Workings
Incremental
Scrap Value
£
750,000.00
£
4,898,250.00
Average
Investment
£
5,648,250.00
Internal Rate
of Return
Year 0 1 2 3 4 5
Incremental
Cash Flows
-£
9,046,500.0
0
-£
18,335,438.00
£
59,562.00
£
7,301,41
2.00
£
14,907,51
7.50
£
23,646,1
56.17
IRR 15.17%
Appendix 5: Sensitivity Analysis
Increase in sales units by 10%

Capital Budgeting Decision Making 28
Years 2019 2020 2021 2022
Initial
Investment
Sales Volume 50000 55000 60500 66550
Selling Price
£
14,000.00
£
14,000.00
£
14,000.00
£
14,000.00
Sales
£
700,000,000.0
0
£
770,000,000.0
0
£
847,000,000.0
0
£
931,700,000.0
0
Material Cost
£
375,000,000.0
0
£
412,500,000.0
0
£
453,750,000.0
0
£
499,125,000.0
0
Labor Cost
£
75,000,000.00
£
82,500,000.00
£
90,750,000.00
£
99,825,000.00
Variable
Overhead
£
110,000,000.0
0
£
121,000,000.0
0
£
133,100,000.0
0
£
146,410,000.0
0
Total Variable
Cost
£
560,000,000.0
0
£
616,000,000.0
0
£
677,600,000.0
0
£
745,360,000.0
0
Contribution
£
140,000,000.0
0
£
154,000,000.0
0
£
169,400,000.0
0
£
186,340,000.0
0

Capital Budgeting Decision Making 29
Fixed Cost
Selling
Expenses
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
Administrative
Expenses
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
Depreciation
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
Research and
Development
Cost
£
3,500,000.00
£
3,605,000.00
£
3,713,150.00
£
3,824,544.50
Increase in new
car component
cost
£
14,500,000.00
£
14,500,000.00
£
14,500,000.00
£
14,500,000.00
Decrease in old
car component
-£
3,000,000.00
-£
3,000,000.00
-£
3,000,000.00
-£
3,000,000.00
Total Fixed
Cost
£
122,424,738.0
0
£
111,029,738.0
0
£
111,137,888.0
0
£
111,249,282.5
0
Profit
£
17,575,262.00
£
42,970,262.00
£
58,262,112.00
£
75,090,717.50
Add
Depreciation
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
Free Cash -£ £ £ £ £

Capital Budgeting Decision Making 30
Flows
9,996,50
0.00 19,414,562.00 44,809,562.00 60,101,412.00 76,930,017.50
Free Cash
Flows
£
-
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
Incremental
Cash Flows
-£
9,996,50
0.00
£
57,164,562.00
£
82,559,562.00
£
97,851,412.00
£
114,680,017.5
0
DCF @ 12% 1.000 0.893 0.797 0.712 0.636
PV of Cash
Flows
-£
9,996,50
0.00
£
51,039,787.50
£
65,815,977.36
£
69,648,702.28
£
72,881,224.35
NPV
£
325,452,
353.62
Years 2019 2020 2021 2022
Initial
Investment
Sales Volume 50000 45000 40500 36450
Selling Price £ £ £ £

Capital Budgeting Decision Making 31
14,000.00 14,000.00 14,000.00 14,000.00
Sales
£
700,000,000.0
0
£
630,000,000.0
0
£
567,000,000.0
0
£
510,300,000.0
0
Material Cost
£
375,000,000.0
0
£
337,500,000.0
0
£
303,750,000.0
0
£
273,375,000.0
0
Labour Cost
£
75,000,000.00
£
67,500,000.00
£
60,750,000.00
£
54,675,000.00
Variable
Overhead
£
110,000,000.0
0
£
99,000,000.00
£
89,100,000.00
£
80,190,000.00
Total Variable
Cost
£
560,000,000.0
0
£
504,000,000.0
0
£
453,600,000.0
0
£
408,240,000.0
0
Contribution
£
140,000,000.0
0
£
126,000,000.0
0
£
113,400,000.0
0
£
102,060,000.0
0
Fixed Cost
Selling
Expenses
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
Administrative
Expenses
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
Depreciation £ £ £ £

Capital Budgeting Decision Making 32
1,839,300.00 1,839,300.00 1,839,300.00 1,839,300.00
Research and
Development
Cost
£
3,500,000.00
£
3,605,000.00
£
3,713,150.00
£
3,824,544.50
Increase in new
car component
cost
£
14,500,000.00
£
14,500,000.00
£
14,500,000.00
£
14,500,000.00
Decrease in old
car component
-£
3,000,000.00
-£
3,000,000.00
-£
3,000,000.00
-£
3,000,000.00
Total Fixed
Cost
£
122,424,738.0
0
£
111,029,738.0
0
£
111,137,888.0
0
£
111,249,282.5
0
Profit
£
17,575,262.00
£
14,970,262.00
£
2,262,112.00
-£
9,189,282.50
Add
Depreciation
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
Free Cash
Flows
-£
9,996,50
0.00
£
19,414,562.00
£
16,809,562.00
£
4,101,412.00
-£
7,349,982.50
Free Cash
Flows
£
-
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00

Capital Budgeting Decision Making 33
Incremental
Cash Flows
-£
9,996,50
0.00
£
57,164,562.00
£
54,559,562.00
£
41,851,412.00
£
30,400,017.50
1.000 0.893 0.797 0.712 0.636
PV of Cash
Flows
-£
9,996,50
0.00
£
51,039,787.50
£
43,494,548.79
£
29,789,008.40
£
19,319,760.71
NPV
£
145,522,
441.60
Increase in
Selling Price by
10%
Electric
Vehicle 2019 2020 2021 2022
Initial
Investment
Sales Volume 50000 52500 55125 57881
Selling Price
£
14,000.00
£
15,400.00
£
16,940.00
£
18,634.00
Sales £ £ £ £

Capital Budgeting Decision Making 34
700,000,000.0
0
808,500,000.0
0
933,817,500.0
0
1,078,559,212
.50
Material Cost
£
375,000,000.0
0
£
393,750,000.0
0
£
413,437,500.0
0
£
434,109,375.0
0
Labour Cost
£
75,000,000.00
£
78,750,000.00
£
82,687,500.00
£
86,821,875.00
Variable
Overhead
£
110,000,000.0
0
£
115,500,000.0
0
£
121,275,000.0
0
£
127,338,750.0
0
Total Variable
Cost
£
560,000,000.0
0
£
588,000,000.0
0
£
617,400,000.0
0
£
648,270,000.0
0
Contribution
£
140,000,000.0
0
£
220,500,000.0
0
£
316,417,500.0
0
£
430,289,212.5
0
Fixed Cost
Selling
Expenses
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
Administrative
Expenses
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
Depreciation
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
Research and £ £ £ £

Capital Budgeting Decision Making 35
Development
Cost 3,500,000.00 3,605,000.00 3,713,150.00 3,824,544.50
Increase in new
car component
cost
£
14,500,000.00
£
14,500,000.00
£
14,500,000.00
£
14,500,000.00
Decrease in old
car component
-£
3,000,000.00
-£
3,000,000.00
-£
3,000,000.00
-£
3,000,000.00
Total Fixed
Cost
£
122,424,738.0
0
£
111,029,738.0
0
£
111,137,888.0
0
£
111,249,282.5
0
Profit
£
17,575,262.00
£
109,470,262.0
0
£
205,279,612.0
0
£
319,039,930.0
0
Add
Depreciation
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
Free Cash
Flows New
Machinery
-£
9,996,50
0.00
£
19,414,562.00
£
111,309,562.0
0
£
207,118,912.0
0
£
320,879,230.0
0
Free Cash
Flows Old
Machinery
£
-
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
Incremental -£ -£ £ £ £

Capital Budgeting Decision Making 36
Cash Flows
9,996,50
0.00 18,335,438.00 73,559,562.00
169,368,912.0
0
283,129,230.0
0
DCF 1.000 0.893 0.797 0.712 0.636
-£
9,996,50
0.00
-£
16,370,926.79
£
58,641,232.46
£
120,553,446.1
6
£
179,933,744.1
9
£
570,244,
836.75
Decrease in
Selling Price by
10%
Electric
Vehicle 2019 2020 2021 2022
Initial
Investment
Sales Volume 50000 52500 55125 57881
Selling Price
£
14,000.00
£
12,600.00
£
11,340.00
£
10,206.00
Sales
£
700,000,000.0
0
£
661,500,000.0
0
£
625,117,500.0
0
£
590,736,037.5
0
Material Cost £ £ £ £

Capital Budgeting Decision Making 37
375,000,000.0
0
393,750,000.0
0
413,437,500.0
0
434,109,375.0
0
Labour Cost
£
75,000,000.00
£
78,750,000.00
£
82,687,500.00
£
86,821,875.00
Variable
Overhead
£
110,000,000.0
0
£
115,500,000.0
0
£
121,275,000.0
0
£
127,338,750.0
0
Total Variable
Cost
£
560,000,000.0
0
£
588,000,000.0
0
£
617,400,000.0
0
£
648,270,000.0
0
Contribution
£
140,000,000.0
0
£
73,500,000.00
£
7,717,500.00
-£
57,533,962.50
Fixed Cost
Selling
Expenses
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
Administrative
Expenses
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
Depreciation
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
Research and
Development
Cost
£
3,500,000.00
£
3,605,000.00
£
3,713,150.00
£
3,824,544.50
Increase in new £ £ £ £

Capital Budgeting Decision Making 38
car component
cost 14,500,000.00 14,500,000.00 14,500,000.00 14,500,000.00
Decrease in old
car component
-£
3,000,000.00
-£
3,000,000.00
-£
3,000,000.00
-£
3,000,000.00
Total Fixed
Cost
£
122,424,738.0
0
£
111,029,738.0
0
£
111,137,888.0
0
£
111,249,282.5
0
Profit
£
17,575,262.00
-£
37,529,738.00
-£
103,420,388.0
0
-£
168,783,245.0
0
Add
Depreciation
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
£
1,839,300.00
Free Cash
Flows New
Machinery
-£
9,996,50
0.00
£
19,414,562.00
-£
35,690,438.00
-£
101,581,088.0
0
-£
166,943,945.0
0
Free Cash
Flows Old
Machinery
£
-
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
Incremental
Cash Flows
-£
9,996,50
0.00
-£
18,335,438.00
-£
73,440,438.00
-£
139,331,088.0
0
-£
204,693,945.0
0
DCF @ 12% 1.000 0.893 0.797 0.712 0.636

Capital Budgeting Decision Making 39
Present Values
-£
9,996,50
0.00
-£
16,370,926.79
-£
58,546,267.54
-£
99,173,116.34
-£
130,086,702.5
9
NPV
-£
466,790,
151.65
Increase in Required
Rate of Return by 2 %
Free Cash
Flows New
Machinery
-£
9,996,50
0.00
£
19,414,562.00
£
37,809,562.00
£
45,051,412.00
£
52,657,517.50
Free Cash
Flows Old
Machinery
£
-
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
Incremental
Cash Flows
-£
9,996,50
0.00
-£
18,335,438.00
£
59,562.00
£
7,301,412.00
£
14,907,517.50
DCF @ 10% 1.000 0.909 0.826 0.751 0.683
Present Values -£
9,996,50
-£ £ £ £

Capital Budgeting Decision Making 40
0.00 16,668,580.00 49,224.79 5,485,658.90 10,182,035.04
NPV
£
3,765,28
7.37
Increase in Required
Rate of Return by 2 %
Free Cash
Flows New
Machinery
-£
9,996,50
0.00
£
19,414,562.00
£
37,809,562.00
£
45,051,412.00
£
52,657,517.50
Free Cash
Flows Old
Machinery
£
-
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
Incremental
Cash Flows
-£
9,996,50
0.00
-£
18,335,438.00
£
59,562.00
£
7,301,412.00
£
14,907,517.50
DCF @ 14% 1.000 0.877 0.769 0.675 0.592
Present Values
-£
9,996,50
0.00
-£
16,083,717.54
£
45,831.02
£
4,928,245.13
£
8,826,447.10
NPV £

Capital Budgeting Decision Making 41
27,346.6
8
Year 2019 2020 2021 2022
Initial
Investment
Sales Volume 50000 52500 55125 57881.25
Selling Price 14000 14000 14000 14000
Sales 700000000 735000000 771750000 810337500
Material Cost 375000000 393750000 413437500 434109375
Labour Cost 75000000 78750000 82687500 86821875
Variable
Overhead 110000000 115500000 121275000 127338750
Total Variable
Cost 560000000 588000000 617400000 648270000
Contribution 140000000 147000000 154350000 162067500
Fixed Cost
Selling
Expenses 85085438 85085438 85085438 85085438
Administrative
Expenses 20500000 20500000 20500000 20500000
Depreciation
£
1,666,083.33
£
1,666,083.33
£
1,666,083.33
£
1,666,083.33
Research and 3500000 3605000 3713150 3824544.5

Capital Budgeting Decision Making 42
Development
Cost
Increase in new
car component
cost 14500000 14500000 14500000 14500000
Decrease in old
car component -3000000 -3000000 -3000000 -3000000
Total Fixed
Cost 122251521.3 110856521.3 110964671.3 111076065.8
Profit 17748478.67 36143478.67 43385328.67 50991434.17
Add
Depreciation 1666083.333 1666083.333 1666083.333 1666083.333
Free Cash
Flows of New
Machinery
-£
9,996,50
0.00 19414562 37809562 45051412 52657517.5
Free Cash
Flows of Old
Machinery 0
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
Incremental
Cash Flows
-£
9,996,50
-£
18,335,438.00
£
59,562.00
£
7,301,412.00
£
14,907,517.50

Capital Budgeting Decision Making 43
0.00
DCF @ 12% 1.000 0.893 0.797 0.712 0.636
PV of Cash
Flows
-£
9,996,50
0.000
-£
16,370,926.78
6
£
47,482.462
£
5,197,000.843
£
9,473,996.875
NPV
£
37,178,2
43.961
Years 2019 2020 2021 2022
Initial
Investment
Sales Volume 50000 52500 55125 57881.25
Selling Price
£
14,000.00
£
14,000.00
£
14,000.00
£
14,000.00
Sales
£
700,000,000.0
0
£
735,000,000.0
0
£
771,750,000.0
0
£
810,337,500.0
0
Material Cost
£
375,000,000.0
0
£
393,750,000.0
0
£
413,437,500.0
0
£
434,109,375.0
0
Labor Cost
£ £ £ £

Capital Budgeting Decision Making 44
75,000,000.00 78,750,000.00 82,687,500.00 86,821,875.00
Variable
Overhead
£
110,000,000.0
0
£
115,500,000.0
0
£
121,275,000.0
0
£
127,338,750.0
0
Total Variable
Cost
£
560,000,000.0
0
£
588,000,000.0
0
£
617,400,000.0
0
£
648,270,000.0
0
Contribution
£
140,000,000.0
0
£
147,000,000.0
0
£
154,350,000.0
0
£
162,067,500.0
0
Fixed Cost
Selling
Expenses
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
£
85,085,438.00
Administrative
Expenses
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
£
20,500,000.00
Depreciation
£
2,499,125.00
£
2,499,125.00
£
2,499,125.00
£
2,499,125.00
Research and
Development
Cost
£
3,500,000.00
£
3,605,000.00
£
3,713,150.00
£
3,824,544.50
Increase in new
car component
cost
£
14,500,000.00
£
14,500,000.00
£
14,500,000.00
£
14,500,000.00
Decrease in old -£ -£ -£ -£

Capital Budgeting Decision Making 45
car component 3,000,000.00 3,000,000.00 3,000,000.00 3,000,000.00
Total Fixed
Cost
£
123,084,563.0
0
£
111,689,563.0
0
£
111,797,713.0
0
£
111,909,107.5
0
Profit
£
16,915,437.00
£
35,310,437.00
£
42,552,287.00
£
50,158,392.50
Add
Depreciation
£
2,499,125.00
£
2,499,125.00
£
2,499,125.00
£
2,499,125.00
Free Cash
Flows of New
Machinery
-£
9,996,50
0.00
£
19,414,562.00
£
37,809,562.00
£
45,051,412.00
£
52,657,517.50
Free Cash
Flows of Old
Machinery 0
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
£
37,750,000.00
Incremental
Cash Flows
-£
9,996,50
0.00
-£
18,335,438.00
£
59,562.00
£
7,301,412.00
£
14,907,517.50
DCF @ 12% 1.000 0.893 0.797 0.712 0.636
Present Value -£ -£ £ £ £

Capital Budgeting Decision Making 46
of Cash Flows
9,996,50
0.000 16,370,926.79 47,482.46 5,197,000.84 9,473,996.88
NPV
-£
11,648,9
46.606