Problem: Capital Budgeting Mini-Case
This is an application of capital budgeting that integrates the projection of a basic cash flow and the computation and analysis of six capital budgeting tools.
Your company is thinking about acquiring another corporation. You have two choices; the cost of each choice is $250,000. You cannot spend more than that, so acquiring both corporations is not an option. The following are your critical data:
a. Corporation A:
1) Revenues = 100K in year one, increasing by 10% each year.
2) Expenses = 20K in year one, increasing by 15% each year.
3) Depreciation Expense = 5K each year.
4) Tax Rate = 25%
5) Discount Rate = 10%
b. Corporation B:
1) Revenues = 150K in year one, increasing by 8% each year.
2) Expenses = 60K in year one, increasing by 10% each year.
3) Depreciation Expense = 10K each year.
4) Tax Rate = 25%
5) Discount Rate = 11%
You must compute and analyze items (a) through (h) using a Microsoft Excel spreadsheet. Make sure that all calculations can be seen in the background of the applicable spreadsheet cells. In other words, leave an audit trail so that others can see how you arrived at your calculations and analysis. Items (i), (j), and (k) should be submitted in Microsoft Word.
c. A 5-year projected income statement
d. A 5-year projected cash flow
e. Net Present Value
f. Internal Rate of Return
g. Payback Period
h. Profitability Index
i. Discounted Payback Period
j. Modified Internal Rate of Return
k. Based on items (a) through (h), which company would you recommend acquiring?
l. In a memo, define, analyze, and interpret the answers to items (c) through (h). Present the rationale behind each item and why it supports your decision stated in item (i). Also, attempt to describe the relationship between NPV and IRR. (Hint: The key factor here is the discount rate used.) In this memo, explain how you would analyze projects differently if they had unequal projected years (i.e., if Corporation A had a 5-year projection and Corporation B had a 7-year projection).