Q3 HPO Capital Budgeting

(a) Estimating cash flows

Year 0 1 2 3 4
Initial investment
Basic cost (3,000,000.00)
Working capital (200,000.00)
Total initial investment (3,200,000.00)

Incremental cash flows

Demand
Growth rate 10%
Net Demand 4,000.00 4,400.00 4,840.00 5,324.00
Price per unit
Inflation rate 5%
Net price 400.00 420.00 441.00 463.05
Net revenue 1,600,000.00 1,848,000.00 2,134,440.00 2,465,278.20
Operating cost 35% 560,000.00 646,800.00 747,054.00 862,847.37
Depreciation cost 750,000.00 750,000.00 750,000.00 750,000.00
Earnings before tax 290,000.00 451,200.00 637,386.00 852,430.83
Tax rate 30%
Earnings after tax 203,000.00 315,840.00 446,170.20 596,701.58
Added Depreciation 750,000.00 750,000.00 750,000.00 750,000.00
Net operating cash flow 953,000.00 1,065,840.00 1,196,170.20 1,346,701.58

Terminal cash flow

Selling price 100,000.00
Net working capital 200,000.00
Net terminal cash flow 300,000.00

Net cash flow (3,200,000.00) 953,000.00 1,065,840.00 1,196,170.20 1,646,701.58

(b) Net present value

0 1 2 3 4
Net cash flow (3,200,000.00) 953,000.00 1,065,840.00 1,196,170.20 1,646,701.58
Req rate of return 15%
Present value (3,200,000.00) 828,695.65 805,928.17 786,501.32 941,506.97
Net present value (2,371,304.35) (1,565,376.18) (778,874.86) 162,632.12

NPV is positive, so the project can be accepted.

Internal Rate of Return

NPV at 15% 162,632.12

0 1 2 3 4
Net cash flow (3,200,000.00) 953,000.00 1,065,840.00 1,196,170.20 1,646,701.58
Req rate of return 25%
Present value (3,200,000.00) 762,400.00 682,137.60 612,439.14 674,488.97
Net present value (2,437,600.00) (1,755,462.40) (1,143,023.26) (468,534.29)

NPV at 25% = (468,534.29)

IRR approximate 16%

IRR of this project is higher than the req rate of return, so should be accepted.

Payback Period

0 1 2 3 4
Net cash flow (3,200,000.00) 953,000.00 1,065,840.00 1,196,170.20 1,646,701.58
Cum net cash flow (2,247,000.00) (1,181,160.00) 15,010.20 1,661,711.78

Payback period 2.99 Years 3 Years

Project should be accepted as it takes less time to recover than other equivalent projects

Finally, we should not accept as according to NPV, and other methods, the project should be accepted.