# Capital Budgeting Mini-Case

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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).

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##### 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.

##### 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 ...

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