A company wants to add a manufacturing machine to an existing factory to accommodate rising demand for their product. The factory is close to its effective capacity now, so the new machine will support sales which are expected to grow linearly during the next four years, topping out at $2,000,000 for years 4 and 5. Sales for each year are forecasted to be: Year 1: $1,000,000 Year 2: $1,500,000 Year 3: $2,000,000 Year 4: $2,000,000 Year 5: $2,000,000 Cash operating costs will be 65% of revenue for each year. The machine has an installed cost of $2,000,000, and will be depreciated straightline over 5 years assuming a 10% salvage value. The salvage amount will also be included as part of the terminal value, representing the amount recaptured at the end of year 5. There will be no tax effect in the salvage value because the book value is expected to be 10% of the historical cost at the end of year 5. There will be no need for additional net working capital in the initial investment, but the need for net working capital will grow in proportion to sales growth. When capacity tops out at the end of year 4, the total net working capital will be $60,000. This amount will be released in the final year as part of the terminal value. The company's WACC (weighted average cost of capital) is 11%, so this will be the required rate of return for this expansion. They also would like a 24-month payback period so that capital will become available for other projects. They are subject to a 25% tax rate. How many months is the pay back period for this proposal? Enter your answer as a number with two decimal places. For example, if your answer is 90.1234, enter 90.12 Type your answer...
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
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