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Unformatted text preview: pital Budgeting: The process of planning for
Capital
purchases of longterm assets.
longterm 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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 Spring '14
 Finance

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