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Capital Budgeting - Explain and Compute Methods.

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A non-profit organization believes it can save $28,000 a year in cash operating costs for the next 10 years with the purchase of a custom-made machine that costs $110,000. This machine is expected to have a zero disposal value. The organization's rate of returns is 14%.
1. Explain and compute the payback period
2. Explain and compute the net present value (NPV)
3. Explain and compute the internal rate of returns (IRR)
4. Explain and compute the accounting rate of returns (ARR)
Using the Net Initial Investment with straight line amortization method.

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Capital Budgeting

Capital Budgeting refers to the process of making long - term planning decisions for investments purposes. It is a decision making and control tool with a primary focus on projects and investments whose impact is over a period of time. Capital budgeting therefore deals with investment decisions that relate to how long term investments are developed, generated, analysed and undertaken.
The primary goal of every firm is to maximize firm value through good investment decisions that will help to increase the value of the firm. The problem that arises as a result of this therefore is the determination of whether it makes sense to commit to one or more investment in order to generate a targeted return on investments. Capital budgeting helps the management of organizations to provide solutions to this strategic problem that confront decision makers in creating values that will help to achieve the corporate investment/project goals and objectives.

The following are the six basic stages in capital budgeting:
1. Identification stage
2. Search stage
3. Information acquisition/Evaluation stage
4. Selection stage
5. Financing stage
6. Implementation and Control stage.

Question:
A non-profit organization believes it can save $28,000 a year in cash operating costs for the next 10 years with the purchase of a custom-made machine that costs $110,000. This machine is expected to have a zero disposal value. The organization's rate of returns is 14%.
1. Explain and compute the payback period
2. Explain and compute the net present value ...

Solution Summary

It is a decision making and control tool with a primary focus on projects and investments whose impact is over a period of time. Capital budgeting therefore deals with investment decisions that relates to how long term investments are developed, generated, analysed and undertaken.

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See Also This Related BrainMass Solution

Letter explaining whether company should acquire computer system: NPV, IRR

See the attached file.

You have been asked to help a local company evaluate a major capital expenditure. The company is a new internet company and must buy a large computer system which will generate additional revenue. The company provides you with the following information:

(Table includes all the necessary information included in the attached file)

Requirements:

a. Write a letter to the president of the company explaining whether the company should acquire the computer system. Utilize both NPV and IRR. Assume that the initial $7,850,000 in annual revenues will grow at a 6% annual rate and that the initial $6,950,000 in annual expenses will grow at a 5% annual rate. The growth starts in year 2 from year 1, i.e. the revenue is year 2 is 8,321,000, etc.

b. Redo this analysis above using sum-of-years digits depreciation method. What happens to the results and would you change your recommendation?

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