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# Alternative Capital Budgeting Techniques

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Futronics Inc. is a \$2 billion firm that sells communications services. Founded in 1937, Futronics has provided consumer products, as well as government systems and services, for well over half a century. Due to a sharp increase in competition, flattened sales, and external economic conditions, Futronics is implementing a corporate overhead reduction program. The proposal is to replace the company's central office stores with outside vendors. The investment will cost \$1,000,000 and yield incremental cash flows of \$450,000 in year one (1), \$350,000 in year two (2), \$300,000 in year three (3), and \$250,000 in year four (4). There is no salvage value of the asset, and the firm has a cost of capital of 8%.

Calculate the net present value, internal rate of return, and simple payback. Next, determine the effect that each of the three (3) values will have on the company.
2.Explain one to two (1-2) investment gains that the company could achieve by outsourcing the central office functions. Focus on the company's potential to reduce overhead and still maintain or even improve the quality of its products.
3.Discuss one (1) capital budgeting method that would be most effective for the company. Next, discuss one (1) capital budgeting method that would have the least value for the company as compared to others. Provide a rationale for your response.

#### Solution Summary

This solution illustrates how to compute the net present value, internal rate of return and payback period using Excel functions. It then discusses ways the company can use its gains from outsourcing to improve its products. Finally, it discusses the most- and least-valuable capital budgeting techniques, and why they were listed as such. Attached in Excel.

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## What is the net present value of investment?

Problem 1
A firm has the following investment alternatives. Each one lasts a year.

Investment A B C
Cash inflow \$1,150 \$560 \$600
Cash outflow \$1,000 \$500 \$500

The firm's cost of capital is 7 percent. A and B are mutually exclusive, and B and C are mutually exclusive.
a. What is the net present value of investment A? Investment B? Investment C?
b. What is the internal rate on investment A? Investment B? Investment C?
c. Which investment(s) should the firm make? Why?
d. If the firm had unlimited sources of funds, which investment(s) should it make? Why?
e. If there were another alternative, investment D, with an internal rate of return of 6 percent, would that alter your anser to question (d)? Why?
f. If the firm's cost of capital rose to 10 percent, what effect would that have on investment A's internal rate of return?

Problem 2

If the cost of capital is 9 percent and an investment costs \$56,000, should you make this investment if the estimated cash flows are \$5,000 for years 1 through 3, \$10,000 for years 4 through 6, and \$15,000 for years 7 through 10?

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