Question

3. Capital Budgeting (20 points) You are considering a new product launch. The project will cost $780,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 180 units per year; price per unit will be $16,300, variable cost per unit will be $11,100, and fixed costs will be $535,000 per year. The required return on the project is 11 percent, and the relevant tax rate is 35 percent. Use NPV, IRR, Profitability index and discounted payback approach to determine whether you should launch the product. Are all these approaches giving you the same decision? If not, which approach would you use to make your final decision? Justify your answer.

Answer 1

Year	Initial Investment or salvage value	Unit Sales	Price per unit	Revenue	Variable Cost	Fixed Cost	Gross Profit (Revenue-VC-FC)	Depreciation Expense	Tax (Gross Profit-Depreciation)*Tax rate	Cash Flow (Gross Profit-Tax)	Present Value (Cash flow/1.11^year)
0	(780,000)	-	-	-	-	-	-	-	-	(780,000)	(780,000)
1	-	180	16,300	2,934,000	1,998,000	535,000	401,000	195,000	72,100	328,900	296,306
2	-	180	16,300	2,934,000	1,998,000	535,000	401,000	195,000	72,100	328,900	266,943
3	-	180	16,300	2,934,000	1,998,000	535,000	401,000	195,000	72,100	328,900	240,489
4	-	180	16,300	2,934,000	1,998,000	535,000	401,000	195,000	72,100	328,900	216,657
										Total (NPV)	240,394.39

As per NPV analysis NPV=240394.39 which is greater than zero. Hence, project should be accepted.

Discounted Payback period= 2+(780000-563249)/240489=2.90 year

PI= (780000+240394.39)/780000=1.30 . As PI >1, project should be accepted.

For IRR

A K Cash Flow (Gross P Profit-Tax) f Year (780,000) 328,900 1 328,900 328,900 2 328,900 Total (NPV) |=IRR(K2: K6) IRR(values, [guess]) IRR

A K Cash Flow (Gross P Profit-Tax) Year f (780,000) 0 328,900 1 328,900 2 328,900 3 328,900 Total (NPV) 24.76% IRR

As IRR> cost of capital, the project should be accepted.

All the method are giving the same decision.