Capital Budgeting
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Benford, Inc. is planning to open a new sporting goods store in a suburban mall. Benford will lease the needed space in the mall. Equipment and fixtures for the store will cost $200,000 and be depreciated over a 5-year period on a straight-line basis to $0. The new store will require Benford to increase its net working capital by $200,000 at time 0; thereafter, net working capital balances are expected to equal 20 percent of the following year's sales. First-year sales are expected to be $1 million and to increase at an annual rate of 8 percent over the expected 10-year life of the store. Operating expenses (including lease payments and excluding depreciation) are projected to equal 70 percent of sales. The salvage value of the store's equipment and fixtures is anticipated to be $10,000 at the end of 10 years. Benford's marginal tax rate is 40 percent.
a. Calculate the store's net present value, using an 18 percent required return.
b. Should Benford accept the project?
c. Calculate the store's internal rate of return
d. Calculate the store's profitability index.
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Solution Summary
Solves the following:
NPV
IRR
Profitability Index
Solution Preview
A. To calculate the NPV or Net Present Value, use a financial calculator. These can also be found online. The link for the calculator used for this problem will be posted underneath the solution.
Depreciation for equipment = (200000 - 10000) / 5 years = 38,000
Tax rate = 40%
You need to input the following:
Discount rate: 18%
Project life: 10 years (Life of store)
Initial cost: 200,000(Equipment) + 200,000 (recommended increase) + 700,000 (operating expenses) = 1,100,000
Since we have operating expenses and depreciation to account for every year, those amounts will be deducted from the cash inflows of all the years (which is expected to increase by 8% every year)
Cash inflow 1 = (20% of 1,000,000) = 200000 - 38,000(depreciation) = 162000
Cash inflow 2 = (1.08 * 200,000) ...
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