To evaluate the current project edmonds should

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To evaluate the current project, Edmonds should identify all the relevant cash inflows and outflows. Cash flows should be after-tax cash flows. Since the timing of cash flows varies over the ten year life of this project, discounted cash flow analysis should be used. Discounted cash flow methods measure all expected future cash inflows and outflows of a project discounted back to the present point in time. 1. b. Edmonds should continually monitor the performance of the project by performing post- audits. This long-term project includes many estimates (such as customer demand, estimated operating costs, etc). Actual cash flows should be compared to estimates to check the accuracy of the forecasts. A post audit will identify problems that need fixing and serve as a control for improving the capital budgeting process for future projects. 2. Qualitative factors in capital budgeting can include: - Identifying the project’s impact on customers. In this project, Edmonds should consider if the new facility will maintain customer satisfaction in regards to the shipping and delivery time. - Identifying the project’s impact on employees. Does Edmonds have adequate access to human capital in this geographical area to staff the new distribution area? What training will be necessary for employees? - Managing employees under project evaluation. This project proposal is based on significant estimates from several different areas of the company (supply chain, marketing, accounting and finance). How will Edmonds handle the post-audits and manage employees who contributed to the project’s initial research? Other factors could be acceptable solutions. 3. Initial cash outflow is $25,000,000 (same for pretax and after-tax) Annual cash flows (years 1-10) Increase in contribution margin $55 x 500,000 = $27,500,000 Increase in annual costs 1,000,000 Net increase in annual operating cash flows (pretax) $26,500,000 Net increase in annual cash flows after tax (x 60%) $15,900,000 Depreciation tax shield: The depreciation on the new building will generate a tax savings (cash inflow) in years 1-10. $25,000,000/10 years = $2,500,000 tax deduction each year x 40% tax rate = $1,000,000 annual tax savings
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425 4. a. Define Net Present Value (NPV) - The difference between the present value of all cash inflows from a project or investment and the present value of all cash outflows required to obtain the investment, or to undertake the project at a given discount rate. b. Define Internal Rate of Return (IRR) - The discount rate that equates the net present value of a stream of cash outflows and inflows to zero. c. Identify one assumption of NPV and one assumption of IRR – IRR method assumes that cash flows can be reinvested at the IRR rate. NPV depends solely on the forecasted cash flows from the project and the opportunity cost of capital; the use of the weighted average cost of capital assumes that the risk of the new project is the same as the riskiness of the rest of the company; another assumption of the NPV is that a dollar today is better than a dollar tomorrow.
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