(solution) Part I: One duty of a financial manager is to choose investments

Part I:

One duty of a financial manager is to choose investments with satisfactory cash flows and rates of return. Therefore, a financial manager must be able to decide whether an investment is worth undertaking and be able to choose intelligently between two or more alternatives. To do this, a sound procedure to evaluate, compare, and select projects is needed. This procedure is called capital budgeting.

Virtually all general managers face capital-budgeting decisions in the course of their careers. The most common of these is the simple ?yes? versus ?no? choice about a capital investment. Regardless of the type of project, however, certain principles of capital budgeting should always be considered. The most important of these principles are:

Focus on cash flows, not profits.

Focus on incremental cash flows.

Account for time.

Account for risk.

Write an essay discussing the meaning and importance of each of these principles as they apply to capital budgeting. Evaluate the importance of each principle and discuss the consequences of ignoring any of these principles.

You must use a minimum of 3 scholarly sources to support your discussion.

Part II:

A private school is considering the purchase of six school buses to transport students to and from school events. The initial cost of the buses is $600,000. The life of each bus is estimated to be five years, after which time the vehicles would have to be scrapped with no salvage value. The school?s management team has derived the following estimates for annual revenues and cost for the next five years.

Year 1

Year 2

Year 3

Year 4

Year 5

Revenues

$330,000

$330,000

$350,000

$380,000

$400,000

Driver costs

$33,000

$35,000

$36,000

$38,000

$40,000

Repairs & maintenance

$8,000

$13,000

$15,000

$16,000

$18,000

Other costs

$130,000

$135,000

$140,000

$136,000

$142,000

Annual depreciation

$120,000

$120,000

$120,000

$120,000

$120,000

The buses would be purchased at the beginning of the project (i.e., in Year 0) and all revenues and expenditures shown in the table above would be incurred at the end of each relevant year.

Because schools are exempt from taxes, the school?s corporate tax rate is 0 percent. A business consultant has advised management that they should use a weighted average cost of capital (WACC) of 10.5 percent to evaluate this project.

Prepare a table showing the estimated net cash flows for each year of the project. Explain all steps involved in your calculation of the Year 1 estimated net cash flow.

Calculate the project?s Payback Period. Explain in your own words, all steps involved in the calculation process.

Calculate the project?s Internal Rate of Return (IRR). Explain in your own words, all steps involved in the calculation process.

Calculate the project?s Net Present Value (NPV). Explain in your own words, all steps involved in the calculation process.

Which is the three evaluation techniques that you computed (i.e., payback period, IRR and NPV), should the firm use to make its decision of whether or not to accept this project? Why? Is one of these techniques better than the others and if so, why?

Finally, what are some risk factors inherent in this capital budgeting analysis? That is, make a list of at least three items that could cause the outcome of this project to be substantially worse than management currently expects (as reflected in their revenue and cost estimates, WACC estimate, etc.). Fully explain each of the risk factors you identify.

Length: 4-5 pages not including title page and references

If the question is not clear, please see the attached file that contains the question 

Please answer all requirements.

Your response should demonstrate thoughtful consideration of the ideas and concepts presented in the course and provide new thoughts and insights relating directly to this topic. Your response should reflect scholarly writing and current APA standards.

Part I:

 

One duty of a financial manager is to choose investments with satisfactory cash flows and

 

rates of return. Therefore, a financial manager must be able to decide whether an

 

investment is worth undertaking and be able to choose intelligently between two or more

 

alternatives. To do this, a sound procedure to evaluate, compare, and select projects is

 

needed. This procedure is called capital budgeting.

 

Virtually all general managers face capital-budgeting decisions in the course of their

 

careers. The most common of these is the simple ?yes? versus ?no? choice about a capital

 

investment. Regardless of the type of project, however, certain principles of capital

 

budgeting should always be considered. The most important of these principles are: Focus on cash flows, not profits. Focus on incremental cash flows. Account for time. Account for risk. Write an essay discussing the meaning and importance of each of these principles as they

 

apply to capital budgeting. Evaluate the importance of each principle and discuss the

 

consequences of ignoring any of these principles.

 

You must use a minimum of 3 scholarly sources to support your discussion.

 

Part II:

 

A private school is considering the purchase of six school buses to transport students to and

 

from school events. The initial cost of the buses is $600,000. The life of each bus is

 

estimated to be five years, after which time the vehicles would have to be scrapped with no

 

salvage value. The school?s management team has derived the following estimates for

 

annual revenues and cost for the next five years.

 

Year 1 Year 2 Year 3 Year 4 Year 5 Revenues $330,000 $330,000 $350,000 $380,000 $400,000 Driver costs $33,000 $35,000 $36,000 $38,000 $40,000 Repairs & maintenance $8,000 $13,000 $15,000 $16,000 $18,000 Other costs $130,000 $135,000 $140,000 $136,000 $142,000 Annual depreciation $120,000 $120,000 $120,000 $120,000 $120,000 The buses would be purchased at the beginning of the project (i.e., in Year 0) and all

 

revenues and expenditures shown in the table above would be incurred at the end of each

 

relevant year. Because schools are exempt from taxes, the school?s corporate tax rate is 0 percent. A

 

business consultant has advised management that they should use a weighted average cost

 

of capital (WACC) of 10.5 percent to evaluate this project. Prepare a table showing the estimated net cash flows for each year of the project.

 

Explain all steps involved in your calculation of the Year 1 estimated net cash flow. Calculate the project?s Payback Period. Explain in your own words, all steps involved

 

in the calculation process. Calculate the project?s Internal Rate of Return (IRR). Explain in your own words, all

 

steps involved in the calculation process. Calculate the project?s Net Present Value (NPV). Explain in your own words, all steps

 

involved in the calculation process. Which is the three evaluation techniques that you computed (i.e., payback period, IRR and

 

NPV), should the firm use to make its decision of whether or not to accept this project? Why?

 

Is one of these techniques better than the others and if so, why?

 

Finally, what are some risk factors inherent in this capital budgeting analysis? That is, make

 

a list of at least three items that could cause the outcome of this project to be substantially

 

worse than management currently expects (as reflected in their revenue and cost estimates,

 

WACC estimate, etc.). Fully explain each of the risk factors you identify. Length: 4-5 pages not including title page and references Your response should demonstrate thoughtful consideration of the ideas and concepts

 

presented in the course and provide new thoughts and insights relating directly to this topic.

 

Your response should reflect scholarly writing and current APA standards.

 

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