Page 163 - DMGT207_MANAGEMENT_OF_FINANCES

Management of Finances

Notes changes. The new machine would use less floor space, which would save $15,000 annually
on the allocated charges for square footage of space used, although the layout of the plant
was such that the left space unoccupied would be difficult to utilize and no other use was
planned. Miscellaneous cash expenses for supplies, maintenance, and power would be
$20,000 less per year, if the automatic machine were used. The purchase price was subject
to 10% investment tax credit that did not reduce the depreciable cost.
Exhibit 1: Mavis Machine Shop Selected Financial Information
Condensed Income Statement, 1979

Neat Sales 85,364,213
Cost of Goods Sold 3,494,941
Selling, General & Administrative 643,706
Profit before Taxes 81,225,566
Income Taxes 602,851
Net Income 8622,715

Condensed Balance Sheet, 12/31/79

Cash 8532.122 Current Liabilities 8930.327
Accounts Receivable 622.107 long-Term Notes Outstanding 500.000
(at 10%)
Inventory 1,858.120 Common Stock 1,000,000
Property Assets 4,390.701 Retained Earnings 5,011,723
87,442,050 87,442,050

Questions
1. Summarize the net cash flows for the proposed project.
2. For the project, calculate the internal rate of return, the accounting rate of return, the
payback period, the net present value and the profitability index.
3. What qualitative factors should be considered in evaluating this project?
4. What decision would you recommend?

6.8 Summary

 Capital budgeting describes the firm's formal planning process for the acquisition and
investment of capital and results in a capital budget.
 Traditional Techniques to Analyze Capital budgeting decisions are Payback period, The
Payback Reciprocal and Accounting Rate of Return (ARR).
 Three discounted cash flow methods used in capital budgeting are Net Present Value
Method (NPV); the Profitability Index or Desirability factor and Internal Rate of Return
(lRR).
 The net present value relies on the time value of money and the timings of cash flows in
evaluating projects.

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