Capital Budgeting

This challenge will focus on capital budgeting.

The student will analyze a new project that will be used to replace an old one. The company wants to conduct capital budgeting for the five-year project. After spending $30,000 on consulting and $45,000 on a market study, they believe that the additional annual sales are going to be $300,000; $600,000; $900,000; $750,000; and $150,000 each year for years 1 through 5, respectively, and the additional annual cost is going to be 40% of the annual sales.

In order to replace the old project, the company would spend $600,000 to purchase new equipment. Additionally, it would pay $20,000 for shipping and $50,000 for installation of the equipment. The new equipment would have an estimated useful life of five years and would be depreciated via a five-year MACRS schedule (i.e., 20.0%, 32.0%, 19.2%, 11.5%, 11.5%, and 5.8%). This project would also require an increase in working capital of $100,000.

When the project is terminated in five years, the estimated salvage value of the new machine is $45,000. The old equipment that is fully depreciated to the book value of $50,000 can be sold for $30,000 today if it is replaced with the new equipment. The required rate of return of this project is 12%, and the company’s marginal tax rate is 34%.