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Finance : Capital Project Budgeting

Question

Capital Project Budgeting

Resources

By successfully completing this assignment, you will demonstrate your proficiency in the following course competencies and assignment criteria:

Competency 2: Apply appropriate budgeting techniques for planning, executing, and controlling.
Calculate elements of a capital budget.
Calculate net present value with income tax implications.
Competency 3: Apply quantitative models to create and manage budgets and forecasts.
Justify a recommendation based on a capital budget.
Competency 5: Communicate in a manner that is consistent with the expectations of a business professional.
Communicate in a manner that is consistent with the expectations of a business professional.

Overview

Capital budgeting techniques allow managers to prioritize resources and make decisions about long-term projects and investments. Capital budget data are useful for making purchase recommendations. In this assignment, you will put capital budgeting into practice, using the background information presented below to calculate the payback period, accounting rate of return, internal rate of return, and net present value in a three-page analysis.

Background

Allgood Incorporated is considering purchasing a new machine to replace a current machine. The new machine will cost \$390,000 and use working capital of \$9,000. The current machine can be sold for \$6,500. The new machine has a five-year useful life and no salvage value. The hurdle rate is 8 percent. If the new machine is purchased, the operating cash inflows are listed below:

Year 1 – \$130,000.
Year 2 – \$130,000.
Year 3 – \$130,000.
Year 4 – \$130,000.
Year 5 – \$130,000 (this includes the \$9000 release of working capital).

Instructions

For this assignment, address the following:

Calculate the following elements of a capital budget (ignoring income taxes for this step):
The payback period.
Accounting rate of return.
Internal rate of return.
Assuming an income tax rate of 40 percent, calculate the net present value. Remember to calculate the after-tax cash flows from operations and the tax savings from depreciation expense in your analysis.
Should Allgood purchase the machine? Write 3–4 pages justifying your position. Include a discussion of what qualitative factors you would consider.