Thursday, October 15, 2009

Capital Budgeting Practice Problem

The company will wind up its business in 8 years.The plant, property and equipment will worth  $ 2000 as a salvage value at the time of winding up the business.

The project costs $40, 000 to launch and opportunity cost associated with this project is 15 % .

Using capital budgeting techniques, is this a good investment for the company?

Accounting Answer:

First, look at the  cumulative cashflows Year 1 to 8 (30) (20) (10) 0 10 20 30 42

Then, this is not a good investment because the payback period is 4 years. The project does not have positive cumulative cash until year 5. Next, the net return after 8 years is 42 on an investment of 40. Less than 15% p.a. return

Therefore, the company should not undertake this project because it would be better off putting its money somewhere else that is more profitable.

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