Problem:
Abel Athletics is considering purchasing new manufacturing equipment that costs $1,300,000 and is expected to improve cash flows by $500,000 in year 1, $350,000 in year 2, $475,000 in year 3, $450,000 in year 4, and $300,000 in year 5.
Key financial metrics for this capital budgeting project have been calculated and provided by the Finance department (see below). A 14% rate of return and a payback period of less than five years are required for the project. These key metrics must include (1) payback period, (2) net present value, and (3) internal rate of return. (Use 6% as the weighted average cost of capital).
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
(1,300,000)
500,000
350,000
475,000
450,000
300,000
pv
438,596
269,314
320,611
266,436
155,811
NPV
150,768
IRR
19%
payback
800,000
450,000
(25,000)
(475,000)
(775,000)
MIRR
17%
In a memo to the CFO, discuss the metrics and make a recommendation whether to accept or reject the project.
Objective: Use effective communication techniques.
Calculate the payback period, net present value, internal rate of return, and modified rate of return for a proposed capital budgeting project.