In capital budgeting the process of planning for

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Unformatted text preview: pital Budgeting: The process of planning for Capital purchases of long-term assets. long-term assets For example: Our firm must decide whether to purchase a new plastic molding machine for RM127,000. How do we decide? RM127,000. Will the machine be profitable? Will profitable Will our firm earn a high rate of return on the Will high investment? investment? The relevant project information follows: The cost of the new machine is RM127,000. RM127,000 Installation will cost RM20,000. RM20,000 RM4,000 in net working capital will be needed at the time of installation. time The project will increase revenues by RM85,000 per The RM85,000 year, but operating costs will increase by 35% of the 35% revenue increase. revenue Simplified straight line depreciation is used. Class life is 5 years, and the firm is planning to keep Class the project for 5 years. Salvage value at the end of year 5 will be RM50,000. Salvage RM50,000 14% cost of capital; 34% marginal tax rate. 34% Capital Budgeting Steps Capital 1)Evaluate Cash Flows Look at all incremental cash flows occurring as a Look result of the project. result Initial outlay Differential Cash Flows over the life of the project (also referred to as annual cash flows). (also Terminal Cash Flows Capital Budgeting Steps Capital 1) 0 Evaluate Cash Flows Evaluate 1 2 3 4 5 6 ... n Capital Budgeting Steps Capital 1) Evaluate Cash Flows Evaluate Initial outlay 0 1 2 3 4 5 6 ... n Capital Budgeting Steps Capital 1) Evaluate Cash Flows 1) Evaluate Initial outlay 0 1 2 3 4 5 6 Annual Cash Flows ... n Capital Budgeting Steps Capital 1) Evaluate Cash Flows 1) Evaluate Terminal Cash flow Initial outlay 0 1 2 3 4 5 6 Annual Cash Flows ... n Capital Budgeting Steps 2) Evaluate the Risk of the...
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