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# Capital Budgeting Report

## Introduction

Capital budgeting is replicated as process in which business evaluates and identifies potential huge expenses along with investment. Generally, expenditures and investments comprises projects like building a new plant or to invest in tenure for long term perspective. This report will explain the fundamentals of corporate finance stemming through different underlying theoretical and principles along with use of principles. Simultaneously, it will communicate range of different arguments in discipline of corporate finance which is proper to audience, via varietal communication media (Ermasova  and Ebdon, 2019). However, this report is an problem solving exercise with use of Excel spreadsheet and leads to high accuracy.

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## Scenario

### Given that:

• WACC or cost of capital: 20%
• Tax rate: 30%
• 10% debenture of \$10000000

### Extraction of cash flow

Q Powerboat

Table 1

 Year Quantity Per boat price Sales revenue Less: Variable cost @ 40% Less: Fixed factory overhead Less: depreciation EBIT 1 650 30000 19500000 7800000 200000 2496000 9004000 2 600 30000 18000000 7200000 200000 2496000 8104000 3 550 30000 16500000 6600000 200000 2496000 7204000 4 500 30000 15000000 6000000 200000 2496000 6304000 5 450 30000 13500000 5400000 200000 2496000 5404000 6 400 30000 12000000 4800000 200000 2496000 4504000

The above scenario is depicting extraction of Earnings before interest and tax over 6 years with use of sales revenue. The per boat price has been specified which is multiplied with quantity of total sale revenue. Further, variable cost has been excluded which is 40% of sales and factory overhead is fixed 200000 over 6 years. Moreover, depreciation is extracted as 2496000 which is also excluded and it originated EBIT of Q Powerboat.

Table 2

 Year EBIT Less: Interest EBT tax @ 30% EAT Add: Depreciation Cash inflow 1 9004000 1000000 8004000 2401200 5602800 2496000 8098800 2 8104000 1000000 7104000 2131200 4972800 2496000 7468800 3 7204000 1000000 6204000 1861200 4342800 2496000 6838800 4 6304000 1000000 5304000 1591200 3712800 2496000 6208800 5 5404000 1000000 4404000 1321200 3082800 2496000 5578800 6 4504000 1000000 3504000 1051200 2452800 2496000 4948800

The table 2 is giving calculation of cash inflow which is extracted with EBIT calculated in above scenario. At the first step, to reach EBT interest is excluded  and to attain EAT 30% tax was deducted as well (Mubashar and Tariq, 2019). Depreciation is considered as accounting method to allocate cost of tangible asset over its useful  life and is implicated for accounting for declining value. It is a non cash accounting charge which does not affect amount of generated cash flow by company. The final cash flow is calculated by adding depreciation in earnings after tax.

Table 3: Assessment of inflows from powerboat parts:

 Year Powerboat cost Variable cost @ 40% Less: loss of income Cash inflow 1 500000 200000 120000 180000 2 1000000 400000 120000 480000 3 1500000 600000 120000 780000 4 2000000 800000 120000 1080000 5 2500000 1000000 120000 1380000 6 3000000 1200000 120000 1680000

The table 3 is reflecting assessment of inflows through parts of powerboat, as here cost of powerboat is specified in 1st column and variable cost is at rate of 40% which is deducted and even loss of income as well. Its outcome of cash inflow is extracted over 6 years for assessing inflows through powerboat reports.

Table 4: Computation of net cash inflow

 Year Cash inflows from Powerboat Cash inflow from Powerboat parts Net cash inflows 1 8098800 180000 8278800 2 7468800 480000 7948800 3 6838800 780000 7618800 4 6208800 1080000 7288800 5 5578800 1380000 6958800 6 4948800 1680000 6628800

The table 4 would help in computing net cash inflow which is difference among cash inflow of company and outflow of specified duration. However, in this aspect cash inflow from powerboat and power boat parts is aggregated in this table of past 6 years.

Table 5: Computation of Net present Value

 Year Cash inflow PV factor @ 20% Net present Value 1 8278800 0.833 6896240.4 2 7948800 0.694 5516467.2 3 7618800 0.579 4411285.2 4 7288800 0.48 3513201.6 5 6958800 0.402 2797437.6 6 6628800 0.335 2220648 Total discounted cash inflow 25355280 Less: Initial investment 21300000 NPV 4055280

Net Present value is known as difference among present value of cash inflows and present value of cash outflows over particular duration. It helps in analysing profitability of forecasted investment or project. The Table 5 gives brief details related to net present value over 6 years (Maáji and Barnett, 2019). Its PV factor and discounted at 20% and it leads to aggregate of discounted cash flow of 25355280. In this project, its initial investment was extracted as 21300000. However, step for calculating Net present value, initial investment is excluded from total discounted cash flow ao with this context its net present value is 4055280 (25355280 – 21300000).

Working note:

Assessment of initial investment

 Particulars Figures Cost of plant \$20,000,000 Installation cost \$800,000 Initial investment in stock \$500,000 Total initial investment \$21300000

Computation of depreciation

 Particulars Figures Cost of plant \$20,000,000 Installation cost \$800,000 Sum of initial investment \$20,800,000 Estimated selling prices \$3,000,000 Period 6 years Straight line rate 12% Depreciation \$20,800,000 * 12% = 2496000

On basis of assessing initial investment extracted with help of cost of plant, installation cost and initial investment in stock. The extraction of initial investment is very important for every method of capital budgeting and helps for taking appropriate business decisions. In the same series, calculation of depreciation is also replicated at straight line method with 12% rate and applicable for 6 years and its final depreciation amount is 2496000.

Table 6

 Computation of Payback period Year Cash inflows Cumulative cash inflows 1 8278800 8278800 2 7948800 16227600 3 7618800 23846400 4 7288800 31135200 5 6958800 38094000 6 6628800 44722800 Initial investment 21300000 Payback period 3 0.7 Payback period 2 year and 4 months

The above table is analysing payback period of Q powerboat which helps in reaching break even point or it could be elaborated that where initial investment cost is covered. Its initial investment is 21300000 which is covered in 2 years and 4 months (Srithongrung and et.al., 2019).

S Powerboat

In this aspect, cash inflows of S powerboat is analysed with use of two capital budgeting method as payback period and other is Net present value.

Table 7: Computation of payback period

 Year Cash inflows Cumulative cash inflows 1 6400000 6400000 2 7400000 13800000 3 7900000 21700000 4 8600000 30300000 5 9300000 39600000 6 14100000 53700000 Initial investment 21300000 Payback period 2 0.9 Payback period 2 year and 9 months

The above table is giving extraction of payback period of 6 years of S powerboat as its initial investment is similar to Q power boat as 21300000. It is clearly viewed that in total 2 years and 9 months it's initial investment was covered.

Table 8 Calculation of NPV

 Year Cash flows PV factors @ 20% Discounted cash inflow 1 6400000 0.833 5333333.333 2 7400000 0.694 5138888.889 3 7900000 0.579 4571759.259 4 8600000 0.482 4147376.543 5 9300000 0.402 3737461.42 6 14100000 0.335 4722061.471 Total discounted cash inflows 27650880.92 Less: Initial investment 21300000 Net present value (NPV) 6850880.92

Net present value is extracted by difference from total discounted cash inflows and initial investment of over 6 years. There is consideration of time value factor and its discounted factor is at rate of 20% of specified duration. However, its initial investment was 21300000 and aggregate of discounted cash inflow is about 27650880.92 of this duration. Henceforth, its net present value is 6850880.92 which is acceptable as well.

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### Comparison of Q boat and S boat

 Particulars Q boat S boat Payback period 2 years and 4 months 2 years and 9 months Net Present Value 4055280 6850880.92

The above table is stating difference in Q powerboat and S powerboat, or in simple words, which project is favourable to organization and gives high benefit with similar initial investment of 21300000. On basis of pay back period, Q power boat is highly advantageous because of fast recovery of initial investment cost as it has variation of 5 months. On the contrary, with consideration of net present value S powerboat is acceptable because of high positive value as compared to Q power boat (Srithongrung, Yusuf and Kriz,  2019). Henceforth, it has been recommended to select S powerboat for investment because it has high net present value and it considers time value of money as well. The payback period does not involve time factor which is great limitation because in the present scenario, it is most important factor for attaining success and make business decisions.

### Conclusion

On basis of above report, it could be concluded that capital budgeting helps in undertaking various business decision and for making strategic plans. It has shown stepwise calculation for extracting cash flow and it has also shown importance of depreciation for analysing business strategic decisions. Thus, it has articulated importance of time value of money concept and here S powerboat is suggested to investment and for benefit.

### References

• Ermasova, N. B. and Ebdon, C., 2019. The Case of Public Capital Budgeting and Management Processes in the United States. In Capital Management and Budgeting in the Public Sector (pp. 23-48). IGI Global.
• Maáji, M. M. and Barnett, C., 2019. Determinants of Capital Budgeting Practices and Risks Adjustment among Cambodian Companies. Archives of Business Research. 7(3).
• Mubashar, A. and Tariq, Y.B., 2019. Capital budgeting decision-making practices: evidence from Pakistan. Journal of Advances in Management Research. 16(2). pp.142-167.
• Srithongrung, A., Yusuf, J. E. W. and Kriz, K. A., 2019. A systematic public capital management and budgeting process. In Capital management and budgeting in the public sector (pp. 1-22). IGI Global.
• Srithongrung, A.and et.al., 2019. Capital management and budgeting in the public sector. IGI Global.

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