Q # 1 – Sneakers Capital Budgeting Projection.
1. Building a factory and purchase / installation of the equipment.
A. Building a factory and purchase / installation of the equipment is determined as initial cost of investment in the Capital Budgeting Process. However building cost would not be incorporated in the NPV calculations, only initial cost of investment of equipmentis always incorporated while calculating the new present value, because it help in determining whether to accept the proposal or not by deducting it from the positive present value of future cash flows
2. Research and Development Cost
A. Research and Development cost are the irrelevant cost and sunk cost, therefore it is not considered in the calculation of the Net Present Value, only the future cash flows are considered while calculating the Net Present Value.
3. Cannibalization of other Sneakers sales
A. The reduction in Sneakers footwear market is the additional cash flow for the New Balance Company, hence resulting in their profitability, as this cannibalization is a form of future cash inflow for the company, and therefore it is relevant while calculating the NPV of the Sneakers.
4. Interest Cost
A. Every interest cost that arises on the loan capital is considered while calculating the cost of capital that is used to discount the investment. Therefore, the interest cost will not be considered again in the calculations of NPV.
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5. Changes in Current Assets / Current Liabilities
A. Changes in current assets/ current liabilities are referred as incremental while calculating the NPV, thus effecting the decision making process. Therefore, it is relevant to incorporate in the NPV calculation process.
A. Tax is considered as the cash flow in bringing into the schedule. Therefore it is relevant in calculations of the NPV.
7. Cost of Goods Sold
A. Cost of Goods Sold is related with all the variable cost of the project that is being appraised for the decision making; therefore it is relevant for the calculation of the NPV.
8. Advertisement and Promotion Expense
A. Advertisement and promotion expense related to the project should be including in the Net Present Value Calculations because it is directly related to the cost of the project, and affecting its profitability. On the other hand, this cost is future cash outflow in the project appraisal making it relevant.
9. Depreciation Charges A. Depreciation is not cash items, which is irrelevant in the capital budgeting process. Therefore it is irrelevant in the calculation of NPV.
Q # 2 – Projected Capital Budgeting
1. What is Project Initial Cash Outlay
A. The initial cash outlay is the amount paid to the stat the project or the investment. This result in the negative amount because of its large initial capital investment made by the organization for the purpose of generation the future positive cash flow in return.
2. What are the annual operating cash flows?
A. The annual operating cash flows for 6 years ranging from 2013 – 2014 is
3. What is the project terminal value
A. The project terminal value at the year 2018 is $ 105,000,000
Q # 3 – Viability on the basis of NPV, IRR and payback method.
A. Payback period determine the time taken to recoup the investment made for a project, this is usually use for the screening a project. But this method does not ignores the timing of cash inflows beyond the payback period, it just focus on the early recovery, even rejects the projects which even offers higher cash inflows. Therefore it is leads viable as a form of investment appraisal tool.
B. Net Present Value (NPV) is the difference of the total cash inflows and the total cash outflows of the project. And then the net cahsflow are discounted by the rate of cost of capital. This technique incorporates all the relevant future cash flow making it more viable in the investment appraisal tools.
C. IRR is the rate of discount at which the PV of the net cash outflows is equal. This is also being determined as the rate of discount, at which the PV of net cash flow related with the project equal to zero. This technique is less viable then NPV technique.
The Sneakers project is viable for the calculation of the NPV, IRR and Payback method.
Q # 1 – Incorporation of cash flows in the forecast.
A. Persistence market share, variable cost, General & Admin cost and advertising and promotion cost should be incorporated in the cash flows as they are all relevant cash flows which are directly attributable to the feasibly of the project.
Q # 2 – Produce the Capital Budgeting Cash flow
A. The initial project outlay is $ 8000.
B. The project annual cash flows are following
C.The project terminal value is $ 7402.
Q # 3 – Viable base for NPV, IRR and Payback
This project is viable for the NPV and IRR calculations, where as for the payback calculations, the data is insufficient
The decision rule of NPV calculation is to accept those project which provide either higher NPV or Positive NPV as compared to the other project. For this, the NPV of the Sneakers project is resulted in the $ 66,132,000. On the other hand, the NPV resulted in the Persistence project results in the NPV of negative – 1,015,000.
Therefore The New Balance should undertake the Sneakers Project as it gives the positive NPV, thus making it feasible.