Capital Budgeting Techniques for Investment Proposals of AYR Co

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TABLE OF CONTENTS
Introduction................................................................................................................................2
Application of Capital Budgeting Techniques...........................................................................2
Project Aspire.........................................................................................................................2
Project Wolf............................................................................................................................4
Analysis and Evaluation.............................................................................................................5
Sources of Finance.....................................................................................................................8
Conclusion................................................................................................................................10
REFERENCES.........................................................................................................................11
APPENDIX 1...........................................................................................................................13
1

Introduction
In the given situation, a company named AYR Co is evaluating two investment proposals so
as to enhance the overall market share for the business and maximise the shareholders’
wealth. For the two proposals (projects) under consideration, market research has been
carried out and capital budgeting analysis is to be carried out based on the information
obtained from the market research. However, the decision making would not solely rely on
quantitative analysis and would also consider selected qualitative parameters. In this
background, the objective of this report is to analyse the two projects and also consider the
key qualitative parameters which should be included in decision making process. Besides,
considering the role of financing, the report also aims to enlist the associated costs and key
stakeholder impact associated with issue of debt and equity.
Application of Capital Budgeting Techniques
The two projects that need to be analysed using capital budgeting techniques are ”Project
Aspire” and “Project Wolf”. In order to apply any of the capital budgeting techniques, the
first step ought to be estimation of the incremental cash flows associated with the given
projects based on the information extended by AYR Co on the basis of the market research.
Project Aspire
A key noteworthy information related to the cost of $ 120,000 incurred in market research
which is considered as a sunk cost owing to the fact that recovery of the same is not possible
even if the company decides not to go ahead with either of the projects. Hence, this cost
would be categorised as a sunk cost which is not of significance to capital budgeting analysis
for either of the given projects (Damodaran, 2015).
On the basis of the information provided, it is apparent that project useful life is for five
years. The initial outlay for this project would lead to $2,250,000 cash outlay incurred with
regards to the acquisition of plant and machinery. Also, incremental working capital
requirement of $ 140,000 is required which is 100% recoverable at the project useful life end.
Besides, it is known that salvage value of the plant machinery at the project end would be $
375,000
Therefore, annual depreciation expense = [(Cost – Salvage Value)/Useful Life] = (2,250,000
– 375000)/5 = $375,000
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It is estimated that the implementation of the project would result in generation of
incremental sales for which incremental variable cost would be incurred and information for
the same has been provided. Besides, for the capital expenditure incurred by the company,
there would be extension of capital allowances which would lead to reduction in outflow of
tax on the incremental profits made. A key aspect of the project is payment of tax in arrears
thereby implying that tax on the profits derived in a particular year would be paid at the end
of the following year only.
Appendix 1 highlights the post-tax incremental cash flows for the project under consideration
considering the information provided. Taking into consideration the projection of incremental
post tax cash flows, the evaluation of the project has been carried out using requisite capital
budgeting tools as highlighted below.
Net Present Value (NPV)
This may be defined as the net sum of present value of all the post-tax incremental cash flows
arising on account of the project during the useful life (Parrino and Kidwell, 2014). As it
considers the time value of money, hence a pivotal input in the form of discount rate is
required which is 10% for the given project. The computation of NPV is indicated as follows.
YEAR
Particulars 0 1 2 3 4 5 6
Incrementa
l cash flows
($)
-2,390,000 1,223,000 1,010,328 1,006,403 1,005,570 1,508,063 -166,599
Present
Value factor
(@10%)
1.00 0.91 0.83 0.75 0.68 0.62 0.56
Present
Value of
Cash flows
($)
-2,390,000 1,111,81
8 834,981 756,125 686,818 936,389 -94,041
NPV 1,842,091
From the above table, it is evident that project NPV is $ 1,842,091.
Internal Rate of Return (IRR)
IRR refers to the discount rate which produces a zero NPV (Arnold, 2015). The computation
of IRR has been facilitated through Excel with the underlying computations indicated below.
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