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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 1,050-1,500-word 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).

Solution Preview

Hi,
See the help in attached Excel Sheet. I have solved the problems and given enough hints for you to work with your memo. Hope this will help. In case of any clarifications get back to me.
Thanks

a. Corporation A:
1) Revenues = 150 K in year one, increasing by 8% each year.
2) Expenses = 60 K in year one, increasing by 10% each year.
3) Depreciation Expense = 10 K each year.
4) Tax Rate = 25%
5) Discount Rate = 11%
6) Initial Purchase price 250 K

A 5-year projected income statement

Year 0 1 2 3 4 5
Revenue 150.00 162.00 174.96 188.96 204.07
Expenses 60.00 66.00 72.60 79.86 87.85
Depreciation 10.00 10.00 10.00 10.00 10.00
Profit Before tax 80.00 86.00 92.36 99.10 106.23
Tax 20.00 21.50 23.09 24.77 26.56
Profit After Tax 60.00 64.50 69.27 74.32 79.67

. A 5-year projected cash flow
Profit After ...

Solution Summary

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. Could be used as a good practice for the exam preparation.

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