ACC501 Assignment No 2 Spring 2012 solution

Capital Budgeting is a planning process that is used to determine whether a firm’s long term investments are financially viable enough to be undertaken. Certain techniques are used in capital budgeting process for assessing the viability of the proposed investments. This assignment will enable the students to understand and apply the capital budgeting techniques for evaluating the feasibility of alternative long-term projects.

BK Brothers (Pvt.) Limited is a sports goods manufacturing company of Sialkot. The company manufactures different sports goods including cricket bats, footballs and tennis rackets. Now, the company has planned to manufacture baseball bats and gloves. In order to manufacture these products, the company needs to install a new manufacturing plant for which it has received two proposals. To analyze these two alternatives, financial analyst of the company Mr. Usman Ali has prepared following estimates of the initial investment and cash inflows associated with the acquisition of new plants:
Plant A Plant B
Initial Investment ( 700,000 ) ( 420,000 )
Years (t) Cash Inflows (CFs)
1 130,000 90,000
2 185,000 125,000
3 170,000 100,000
4 172,000 92,000
5 450,000 220,000
Mr. Usman Ali has analyzed both projects for a period of 5 years. According to his analysis, the plants would be sold after 5 years resulting large fifth-year cash inflows. He feels that although the two plants have similar risk but plant A has a much higher initial investment. He has applied the firm’s cost of capital (required rate of return) of 12% while analyzing the options. BK Brothers (Pvt.) Limited requires all projects to have a maximum payback period of 4 years.
REQUIRED:
a. Use the following capital budgeting techniques to evaluate the feasibility of each plant:
(1) Payback Period ( 3 + 3 = 06 Marks)
(2) Net Present Value (NPV) ( 5 + 5 = 10 Marks)
(3) Internal Rate of Return (IRR) ( 6 + 6 = 12 Marks)
b. On the basis above findings, summarize your results according to the following format and interpret which plant the company should acquire and why? ( 1 + 1 = 02 Marks)
Capital Budgeting
Technique
Plant A Plant B
Which Plant is
Better?
Payback Period (Years)
Net Present Value (Rs.)
Internal Rate of Return (%)
Decisive Interpretation: (Which Plant should be acquired and why?)

Solution:

 

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