FIN 4310 California Miramar University Basics of Capital Budgeting Case Study

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FIN 4310

California Miramar University

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11 Case model 2/11/2020 17:08 Chapter 11. The Basics of Capital Budgeting You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with products from Daimler AG, Ford, Toyota, and other automakers. Your boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm’s ignition system line; it would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3-year lives because Allied is planning to introduce entirely new models after 3 years. Here are the projects' cash flows (in thousands of dollars): Year 0 1 2 3 CFL ($100) $10 $60 $80 CFS ($100) $70 $50 $20 Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. The CFO also made subjective risk assessments of each project, and he concluded that both projects have risk characteristics that are similar to the firm's average project. Allied’s WACC is 10%. You must determine whether one or both of the projects should be accepted. (1) What is each project’s NPV? WACC 10% The solution can be found using Excel's NPV function, which finds the NPV of CF 1 to CFN, and then add the value of CF0 to the result. NPVL = NPVS = Choose both projects if they're independent, but if they're mutually exclusive choose Project S. (2) What is each project’s IRR? The internal rate of return (IRR) is that discount rate which forces the NPV of a project to equal zero. The solution to this equation can be found using Excel's IRR function. IRRL = IRRS = Choose both projects if they're independent, but if they're mutually exclusive choose Project S. As a separate project (Project P), the firm is considering sponsoring a pavilion at the upcoming World's Fair. The pavilion would cost $800,000, and it is expected to result in $5 million of incremental cash inflows during its one year of operation. However, it would then take another year, and $5 million of costs, to demolish the site and return it to its original condition. Thus, Project P's expected cash flows (in millions of dollars) look like this: Year 0 1 2 Cash Flow ($0,8) $5,0 ($5,0) WACC The project is estimated to be of average risk, so its WACC is 10%. (3) What is Project P’s NPV? What is its IRR? = 10% NPV IRR = = However, since this project has nonnormal cash flows, we must be aware of the possibility of multiple IRRs. Therefore, we will perform the IRR calculation again, but this time a guess of 300% will be entered to test for another IRR. IRR = Indeed, it is revealed that two IRRs exist. Because there are two sign changes in the cash flow stream, we can be sure that there are two and only two IRRs. Grading / Rubrics Matrix Points (PTS) and Content (CNT) Level 1 Pts Cnt Original Posts (Total Maximum Points) Level 2 Pts Cnt 7 Critical Thinking Responding to Others' Thoughts Rich in Content, Full of Thoughts Insightful Analyis, Substantial Info Level 3 Pts Cnt 5 2 Level 4 Pts Cnt 3 1,5 0 1 X X X X X X X X X X X 0 Word Counts, Minimum: DBA: 500 - 700 Words MBA: 300 - 400 Words BSBA, ASBA: 100 - 200 Words Rudimentary & Superficial No Insightful Analysis Less Than Minimum Words X X X Connecting to … Previous Knowledge Currently Discussed Knowledge Class Related Topics Referencing Real Life Scenario(s) No Depth nor Details No Connection, Misses theTopic 2 Time Line (3 Points at Risk !! ) by Wednesday by Thursday by Friday (After Friday: 0 Points) 1 Research All Intext Citations All Ref. in APA Format Some intext Citations Some Ref in APA Format All missing 2 Participation, Peer Responses (*) (**) 1st Responses Rich in Content 2nd Response Rich in Content 3rd Response Rich in Content Active Participation in class 1,5 Severe Severe Severe 1 0 X X X X X 0,5 X Severe X 0 Later Than Friday 0,5 X X 1,5 0,5 0 X X X X X 4 4 4 X 3 3 3 1 3 3 2 3 3 1 - Severe 2 2 0 2 2 1 - X Later Word Counts, Minimum: DBA: 300 - 500 Words MBA: 200 - 300 Words BSBA, ASBA: 100 - 200 Words Not as Rich in Content Rudimentary and Superficial Total Possible Points (*) X X X X X X X X X 15 11 X 7 Points depending on submission on or before Sunday !! (**) Points depending on whether 2 or 3 Peer Responses are required Matrix by Dr. Georg Schlueter, Corrected to match Faculty Handbook V.5.0, Dec 26, 2019 1 Than Sunday 0
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11 Case model

2/13/2020 16:04

Chapter 11. The Basics of Capital Budgeting

You recently went to work for Allied Components Company, a supplier of auto repair parts used
in the after-market with products from Daimler AG, Ford, Toyota, and other automakers.
Your boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two
proposed projects. Project L involves adding a new item to the firm’s ignition system line; it would
take some time to build up the market for this product, so the cash inflows would increase over
time. Project S involves an add-on to an existing line, and its cash flows would decrease over
time. Both projects have 3-yea...


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