Capital Budgeting Report: Analyzing Q & S Powerboat Projects, FIN20014

This report presents a capital budgeting analysis for Pentag Company, evaluating the profitability and feasibility of two powerboat projects: Q-Powerboat and S-Powerboat. The analysis includes detailed financial projections over a six-year period, considering factors such as equipment costs, sales revenue, variable and fixed costs, depreciation, and working capital. The report calculates key metrics like Net Present Value (NPV), Internal Rate of Return (IRR), and discounted payback period at both 20% and 25% discount rates. Both projects are assessed based on quantitative characteristics and qualitative aspects, including a condition that the discounted payback period should not be more than four years. The report concludes that while both projects initially seem promising with positive NPV and IRR, they fail to meet the payback period requirement, leading to a recommendation against their implementation. The analysis also includes a cross-over rate calculation and provides a comparative assessment, suggesting Q-Powerboat as a better option if the payback period constraint is removed. The report utilizes financial management principles to make informed investment recommendations.

Running head: FINANCIAL MANAGEMENT
Financial management
Name of the student
Name of the university
Student ID
Author note

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Table of Contents
Introduction......................................................................................................................................2
Findings...........................................................................................................................................2
Computation for Q-Powerboat....................................................................................................2
Quantitative characteristic...........................................................................................................3
Qualitative characteristics............................................................................................................5
Computation for S-Powerboat.....................................................................................................5
Cross over rate.............................................................................................................................7
Conclusion and recommendation....................................................................................................7
Reference and bibliography.............................................................................................................8
Appendix........................................................................................................................................10

2FINANCIAL MANAGEMENT
Introduction
Pentag Company manufactures small powerboats and at present facing challenges in
building and marketing green powerboats environment friendly. As per the view of the entity’s
director building of green powerboat is possible however, the market condition and demand are
not optimum at present. The report will analyse the profitability and acceptability of new project
Q-powerboat that is being considered by the entity at present for manufacture. In addition to that
Pentag has another project to consider that is S-Powerboat that is considered to be more
environment friendly as compared to Q-Powerboat (Baddeley 2017)
Findings
Computation for Q-Powerboat
Analysis of Q-Powerboat
Year 0 1 2 3 4 5 6
Cost of
equipment
$ -
20,000,00
0.00
Installation cost
of equipment
$ -
800,000.0
0
Sales in units 650.00 600.00 550.00 500.00 450.00 400.00
selling price per
unit
$
30,000.00
$
30,000.00
$
30,000.0
0
$
30,000.0
0
$
30,000.00
$
30,000.00
Sales revenue
$
19,500,00
0.00
$
18,000,000.0
0
$
16,500,0
00.00
$
15,000,0
00.00
$
13,500,00
0.00
$
12,000,000.0
0
Variable cost
$ -
7,800,000
.00
$ -
7,200,000.00
$ -
6,600,00
0.00
$ -
6,000,00
0.00
$ -
5,400,000
.00
$ -
4,800,000.00
Fixed cost
$ -
200,000.0
0
$ -
200,000.00
$ -
200,000.
00
$ -
200,000.
00
$ -
200,000.0
0
$ -
200,000.00
Depreciation
$ -
2,496,000
.00
$ -
2,496,000.00
$ -
2,496,00
0.00
$ -
2,496,00
0.00
$ -
2,496,000
.00
$ -
2,496,000.00

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opportunity
sales revenue
$
500,000.0
0
$
500,000.00
$
500,000.
00
$
500,000.
00
$
500,000.0
0
$
500,000.00
Cost of
production
$ -
200,000.0
0
$ -
200,000.00
$ -
200,000.
00
$ -
200,000.
00
$ -
200,000.0
0
$ -
200,000.00
Opportunity loss
on earnings
$ -
10,000.00
$ -
10,000.00
$ -
10,000.0
0
$ -
10,000.0
0
$ -
10,000.00
$ -
10,000.00
Working capital
$ -
700,000.0
0
Cash flow before
tax
$ -
21,500,00
0.00
$
9,294,000
.00
$
8,404,000.00
$
7,494,00
0.00
$
6,604,00
0.00
$
5,694,000
.00
$
4,804,000.00
Tax @ 30%
$
-
$ -
2,788,200
.00
$ -
2,521,200.00
$ -
2,248,20
0.00
$ -
1,981,20
0.00
$ -
1,708,200
.00
$ -
1,441,200.00
Cash flow after
tax
$ -
21,500,00
0.00
$
6,505,800
.00
$
5,882,800.00
$
5,245,80
0.00
$
4,622,80
0.00
$
3,985,800
.00
$
3,362,800.00
Add: Salvage
value
$
3,000,000.00
Add:
Depreciation
$
2,496,000
.00
$
2,496,000.00
$
2,496,00
0.00
$
2,496,00
0.00
$
2,496,000
.00
$
2,496,000.00
Free cash flow
$ -
21,500,00
0.00
$
9,001,800
.00
$
8,378,800.00
$
7,741,80
0.00
$
7,118,80
0.00
$
6,481,800
.00
$
8,858,800.00
Discounting
factor @ 20% 1 0.83 0.69 0.58 0.48 0.40 0.33
Discounted cash
flow
$ -
21,500,00
0.00
$
7,501,500
.00
$
5,818,611.11
$
4,480,20
8.33
$
3,433,06
3.27
$
2,604,890
.05
$
2,966,794.20
Discounting
factor @ 25% 1 0.80 0.64 0.51 0.41 0.33 0.26
Discounted cash
flow
$ -
21,500,00
0.00
$
7,201,440
.00
$
5,362,432.00
$
3,963,80
1.60
$
2,915,86
0.48
$
2,123,956
.22
$
2,322,281.27
At 20% disc rate At 25% disc rate
NPV $ 5,305,066.96 $ 2,389,771.57
IRR 30% 30%
Discounted payback period 4.10 4.97

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Quantitative characteristic
From above table and outcomes following analysis can be made –
 Net present value – NPV is an investment appraisal technique used for determining
current value of all the future cash inflows that is the estimated future cash flows from the
project after deducting the amount of initial expenses spend for acquiring the project.
When NPV technique is used to evaluate the project’s acceptability, positive NPV
indicates that the project is acceptable. On the contrary, the negative NPV indicates that
the project is not acceptable (Žižlavský 2014). From the computation it is clear that the
Q-Powerboat project is generating positive NPV amounting to $ 53,05,066.96 applying
20% WACC. Hence, based on the outcome of NPV the project is acceptable.
 Discounted payback period – it is a capital budgeting approach used for computing
project’s acceptability. It provides the investor with the time period required for covering
up the amount of initial expenses spend for acquiring the project. When DPP technique is
used to evaluate the project’s acceptability, DPP of less than the project’s life time
indicates that the project is acceptable. On the contrary, the DPP of more than the
project’s life time indicates that the project is not acceptable (Qiu, Wang and Wang
2015). From the computation it is clear that the Q-Powerboat project’s initial investment
will be recovered in 4.10 years that is lower than its life time of 6 years applying 20%
WACC. Hence, based on the outcome of DPP the project is acceptable.
 Internal rate of return – it is the core component of capital budgeting approach and is
used to evaluate the project’s rate of return. When IRR technique is used to evaluate the
project’s acceptability, IRR of more than the WACC indicates that the project is
acceptable. On the contrary, the IRR of less than the WACC indicates that the project is

5FINANCIAL MANAGEMENT
not acceptable (DeFusco et al. 2015). From the computation it is clear that the Q-
Powerboat project’s IRR is 30% that is more than its WACC of 20%. Hence, based on
the outcome of IRR the project is acceptable.
Qualitative characteristics
Taking into consideration all the above mentioned factors and outcomes it is identified
that the project is fulfilling all the aspects required for accepting any project. However, one
attached condition of the entity for accepting the project is the DPP shall not be more than 4
years. However, it is found from the outcomes that the DPP of the project at 20% WACC is 4.10
years that is more than the required time period of 4 years. Hence, as the project is not fulfilling
the requirement of payback period it is not acceptable
Computation for S-Powerboat
Analysis of S-Powerboat
Year 0 1 2 3 4 5 6
Free cash flow
$ -
21,500,00
0.00
$
6,400,000.
00
$
7,400,000.0
0
$
7,900,00
0.00
$
8,600,00
0.00
$
9,300,000.
00
$
11,100,000.0
0
Discounting
factor @ 20% 1 0.83 0.69 0.58 0.48 0.40 0.33
Discounted
cash flow
$ -
21,500,00
0.00
$
5,333,333
.33
$
5,138,888.8
9
$
4,571,75
9.26
$
4,147,37
6.54
$
3,737,461.
42
$
3,717,367.5
4
Discounting
factor @ 25% 1 0.80 0.64 0.51 0.41 0.33 0.26
Discounted
cash flow
$ -
21,500,00
0.00
$
5,120,000
.00
$
4,736,000.0
0
$
4,044,80
0.00
$
3,522,56
0.00
$
3,047,424.
00
$
2,909,798.4
0
At 20% disc rate At 25% disc rate
NPV $ 5,146,186.99 $ 1,880,582.40
IRR 28% 28%
Discounted payback
period 4.62 5.35

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Comparison
Q-Powerboat S-Powerboat
At 20% disc rate At 25% disc rate At 20% disc rate At 25% disc rate
NPV 5305066.958 2389771.571 5146186.986 1880582.4
IRR 30% 30% 28% 28%
Discounted payback period 4.10 4.97 4.62 5.35
As the entity is facing some issues regarding high carbon emission by Q-Powerboat and
is considering undertaking S-Powerboat that is considered to be more environment friendly as
compared to Q-Powerboat. Cash outflows of S-Powerboat are same as Q-Powerboat, however,
the cash flow for its useful life that is for 6 years period vary from Q-Powerboat. From the
computation it is clear that the S-Powerboat project is generating positive NPV amounting to $
51,46,186.99 applying 20% WACC and $ 18,80,582 applying WACC of 25%. Hence, based on
the outcome of NPV the project is acceptable. From the computation of DPP it is clear that the S-
Powerboat project’s initial investment will be recovered in 4.62 years when WACC is 20% and
in 5.35 years when WACC is 25% that is lower than its life time of 6 years. Hence, based on the
outcome of DPP the project is acceptable. Further, it is clear that the S-Powerboat project’s IRR
is 28% that is more than its WACC of 20% as well as 25% both. Hence, based on the outcome of
IRR the project is acceptable (Dhavale and Sarkis 2018). Taking into consideration all these
factors and outcomes it is identified that the project is fulfilling all the aspects required for
accepting any project. However, as per the attached condition for accepting the project, DPP
shall not be more than 4 years. However, it is found from the outcomes that the DPP of the
project at 20% WACC is 4.62 years and at 25% WACC it is 5.35 years, hence both are more

7FINANCIAL MANAGEMENT
than the required time period of 4 years. Hence, as the project is not fulfilling the requirement of
payback period it is not acceptable.
Cross over rate
Cross over rate is the rate at which NPV of one project crosses over NPV of another
project. It is useful in analysis of capital budgeting as it states the rate at which the NPV of
mutually exclusive project is same. If the cost of capital crosses the cross over rate the
acceptability of the project alters. For instance, if project is acceptable at below rate of cross over
rate, project B becomes acceptable while the cost of capital exceeds the cross over rate
(Corporate Finance Institute 2019). From the computation shown below it can be found that the
crossover rate of the projects is 18%.
Year Free Cash flow Difference
Q-Powerboat S-Powerboat
0 $ -21,500,000.00 $-21,500,000.00 $ -
1 $ 9,001,800.00 $ 6,400,000.00 $ 2,601,800.00
2 $ 8,378,800.00 $ 7,400,000.00 $ 978,800.00
3 $ 7,741,800.00 $ 7,900,000.00 $ -158,200.00
4 $ 7,118,800.00 $ 8,600,000.00 $ -1,481,200.00
5 $ 6,481,800.00 $ 9,300,000.00 $ -2,818,200.00
6 $ 8,858,800.00 $ 11,100,000.00 $ -2,241,200.00
Cross-over rate 18%
Conclusion and recommendation
It is concluded from the above that both the projects are satisfying the criteria for
accepting the project. However, they are not fulfilling the criteria of DPP for 4 years as both the
projects DPP at both WACC of 20% and 25% is more than 4 years. Hence, both the projects are
not acceptable and it is recommended that the projects shall not be proceeded with. However, if

8FINANCIAL MANAGEMENT
the condition of DPP is not there Q-Powerboat is better as compared to S-Powerboat as its IRR
and NPV is more than S-Powerboat.

9FINANCIAL MANAGEMENT
Reference and bibliography
Baddeley, M., 2017. Investment: Theories and Analyses. Macmillan International Higher
Education.
Corporate Finance Institute., 2019. Crossover Rate - Formula, Examples, and Guide to Discount
Rate, NPV. [online] Available at:
https://corporatefinanceinstitute.com/resources/knowledge/valuation/crossover-rate/ [Accessed 9
May 2019].
DeFusco, R.A., McLeavey, D.W., Pinto, J.E., Anson, M.J. and Runkle, D.E., 2015. Quantitative
investment analysis. John Wiley & Sons.
Dhavale, D. G., and Sarkis, J., 2018. Stochastic internal rate of return on investments in
sustainable assets generating carbon credits. Computers & Operations Research, 89, 324-336.
Götze, U., Northcott, D., and Schuster, P., 2015. Discounted Cash Flow Methods. In Investment
Appraisal (pp. 47-83). Springer, Berlin, Heidelberg.
Qiu, Y., Wang, Y. D., and Wang, J., 2015. Implied discount rate and payback threshold of
energy efficiency investment in the industrial sector. Applied Economics, 47(21), 2218-2233.
Santandrea, M., Sironi, A., Grassi, L., and Giorgino, M., 2017. Concentration risk and internal
rate of return: Evidence from the infrastructure equity market. International Journal of Project
Management, 35(3), 241-251.
Shu, S. B., Zeithammer, R., and Payne, J. W., 2016. Consumer preferences for annuity attributes:
Beyond net present value. Journal of Marketing Research, 53(2), 240-262.

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Trianni, A., Cagno, E. and Farné, S., 2016. Barriers, drivers and decision-making process for
industrial energy efficiency: A broad study among manufacturing small and medium-sized
enterprises. Applied Energy, 162, pp.1537-1551.
Žižlavský, O., 2014. Net present value approach: method for economic assessment of innovation
projects. Procedia-Social and Behavioral Sciences, 156, pp.506-512.

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Appendix
Formula
Q-Powerboat –
S-Powerboat –