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Capital budget analysis of two investment projects

Question

Discussion

Project A involves adding a new component to an automobile’s emissions control system. Initially available only for Ford vehicles, it will be available for other models later. Because of its potential axis, it may have to compete with new entrants who want to manufacture and sell similar products.

Project B is a special air conditioner adapter for older Ford and his GM vehicles. New vehicles from Ford and GM will have this item as standard equipment, but there will likely be an immediate market in China. Many Chinese customers want American cars, but cannot afford the full price of new models.

Answer

Axis Corporation plans to expand its business by investing in new projects to manufacture new advanced automotive spare parts. The company has two potential projects for him. One is to manufacture new components for automobile emissions control systems and the other is to manufacture air conditioning adapters for Ford and his GM vehicles. The report evaluates and analyzes both investment projects using capital budgeting and investment valuation techniques to help select the most viable investment option.

Our product staff estimates the expected demand for our products, resulting in expected sales for the next three years. In addition, it was estimated that the cost of goods sold accounted for his 60% of sales revenue. Therefore, before choosing an investment proposal among the available projects, it is necessary to evaluate and analyze the profitability and feasibility of the project. Using a straight-line depreciation estimate, a tax rate of 30%, and a discount rate of 14%, the project can be valued using the following investment valuation techniques:

Project A has an initial investment of $120,000 and an expected useful life of 3 years. Based on the estimated sales amount estimated by the production staff, the following analysis is possible.

From the analysis above, we can see that Project A generates $45,600 of net cash flow from operations in its first year, with a significant increase in cash flow thereafter. We can see that Project A has an NPV of $43,887 and an internal rate of return of 31%. The discounted payback period is 2.44 years, the profitability index is 1.37, and the accounting rate of return is 61.33%.

Project B requires an initial investment of $130,000. This is based on the lifetime of the project. depreciated to zero. Estimates of expected revenue, tax rates, and discount rates allow you to perform the following analyses:

From the above analysis, it can be seen that the cash flow generated by the operation of the project B was $118,000 in the first year, but the cash flow generation gradually decreased in the following years. The project has a net present value of $41,084 and an internal rate of return of 37%. The discount payback period for this project will be short at 1.7 years. Project B has an accounting rate of return of 54.15% and a profitability index of 1.32.

From the above calculation, the company’s weighted average cost of capital is 9%. If we take the weighted average cost of capital as the required rate of return, we can conclude that his IRR for both projects is higher than the required rate of return, and his IRR for project B is higher.

Conclusions and Recommendations

From the discussion and analysis above, Project A performs better than Project A because both projects have positive NPV. We can conclude that it is possible. Project B has a higher internal rate of return and a shorter payback period, but Project A leads to higher capital accumulation than Project B. Therefore, we recommend that you select Project A for investment.

References

Alkaraan, Fadi. “Prospects for Strategic Investment Decisions.” M&A Progress 14 (2015): 53-66.

Baum, Andrew E., Neil Crosby. Valuation of real estate investment. John Wiley & Sons, 2014.

Harris, Elaine. Strategic project risk assessment and management. Routledge, 2017.

Nadkarni, G.A “Investment evaluation for industrial enterprises” (2016).