Capital Budgeting

Topics: Net present value, Investment, Discount rate Pages: 3 (644 words) Published: February 8, 2012
Capital Budgeting

Financial Management- FIN 534

Problem 23A
For the base-case scenario, what is the NPV of the plant to manufacture lightweight trucks?
Bauer Industries is an automobile manufacturer. Like any other company, the management team is considering making an investment and must consider all aspect before accepting a proposal. Bauer Industries must evaluate their proposal to build a plant that will manufacture lightweight trucks. The company has set a 12% cost of capital. IT is important that the proposal has positive NPV or it will not be a smart business move for Bauer Industries.

NPV is defined as the difference between the present value of its benefits and the present value of its cost. The formula used to calculate net present value is NPV=PV (benefits)-PV (costs). Many companies consider the formula the golden rule for financial decision making. Decision makers look for positive NPV or the investment is not considered. In this case, the NPV of the plant to manufacture lightweight trucks is positive. NPV=-150 x 36 x 1.12(1-11-12x9)+481.12x10=57.3 million

Problem 23B
What is the NPV of this project if revenues are 10% higher than forecast? What is the NPV if revenues are 10% lower than forecast?
Sensitivity analysis is another great capital budgeting tool to use when evaluating investments or making business decisions within a firm or company. If a company use the sensitivity analysis, the company are able to divide the NPV calculations into different groups of assumptions. This process then will show how NPV varies to change. This can either be positive or negative. While Bauer Industries are considering this venture, they are smart to be uncertain about their projected assumptions when in reality their forecast could generate totally opposite results.

The sensitivity analysis also gives data that can be used to determine which assumptions are most important. This will allow Bauer Industries to invest and refine...
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