Calculations Shown


1. List the three steps that make up the general approach to capital budgeting.

2. Define an “Incremental cash flow” as the term is used in capital budgeting.

Incremental cash flow is the additional operating cash flow that an organization receives from taking on a new project. A positive incremental cash flow means that the company’s cash flow will increase with the acceptance of the project.

3. Your firm is considering buying a new machine that costs $200,000, is expected to generate $110,000 in new revenue each year and will cost $45,000 a year to operate. If your firm’s marginal income tax rate is 35% what is the Net Cash Flow your firm will realize from the new machine during the first year? Assume the MACRS depreciation rate for the machine for year 1 is 20%. Note – do not include the cost of the machine in your answer.

4. Define the payback period method in capital budgeting and state the payback period decision rule.

5. What is the payback period of the following project?

Initial Investment: $50,000
Projected life: 8 years
Net cash flows each year: $10,000

6. Consider the following income statement and answer the questions that follow:
Sales (100 units) $200
Variable costs ($.80 ea) 80
Fixed Costs 20
EBIT 100
Interest Expense 30
EBT 70
Income tax 24
Net Income 46

a. What is the firm’s Breakeven Point in units?
b. Draw a breakeven chart for this firm.

7. Define the Net present Value (NPV) method in capital budgeting and state the NPV decision rule. In economic terms, what does the NPV amount represent?

NPV is the acronym for net present value. Net present value is a calculation that compares the amount invested today to the present value of the future cash receipts from the investment. In other words, the amount invested is compared to the future cash amounts after they are discounted by a specified rate of return.

8. Your firm is looking at a new investment opportunity, Project Alpha, with net cash flows as follows:

—- Net Cash Flows —-
Project Alpha
Initial Cost at T-0 (Now) ($10,000)
cash inflow at the end of year 1 6,000
cash inflow at the end of year 2 4,000
cash inflow at the end of year 3 2,000
Calculate project Alpha’s Net Present Value (NPV), assuming your firm’s required rate of return is 10%.

9. Define the Internal Rate of Return (IRR) method in capital budgeting and state the IRR Decision rule.

10. Calculate the IRR of the following project:

Year Cash Flow

0 -$30,000

1 $40,000