Payback period, NPV, IRR
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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 attached). 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).
In a memo to the CFO, discuss the metrics and make a recommendation whether to accept or reject the project.
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Solution Summary
Response explains the steps to know payback period, NPV, IRR
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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 attached). 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).
Salient points of analysis of Capital Budgeting tools
Capital budgeting involves taking decisions about the long term assets mix of the organization. One uses following tools for analyzing a project:
1) NPV
2) Payback
3) IRR
4) MIRR
NET PRESENT VALUE: The net present value (NPV) method offsets the present value of an investment's cash inflows against the present value of the cash outflows. If a prospective investment has a positive net present value ...
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