Accounting 505 Project B
Capital Budgeting is the process in which a business determines whether projects such as building, new plants or investing in a long-term venture are worth pursuing. Sometimes, a prospective project's lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target benchmark (“Capital Budgeting” 2014). The most popular methods of capital budgeting is: net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF) and payback period. The term "present value" in NPV refers to the fact that cash flows earned in the future are not worth as much as cash flows today. (Gad, S” nd). The payback period is done by calculating the total cost of the project and divide it by how much cash inflow you expect to receive each year; this will give you the total number of years or the payback period (Gad, S nd). The internal rate of return (IRR) is a discounted rate that is commonly used to determine how much of a return an investor can expect to realize from a particular project. The internal rate of return is the discount rate that occurs when a project is break even, or when the NPV equals 0. Here, the decision rule is simple: choose the project where the IRR is higher than the cost of financing (Gad, S nd).
My recommendation for Clark Paints proposal would be to accept the proposal to make their own paint cans. The bottom line would increase by $26,351.00 per year after taxes. The investment exceeds the required rate of return. The equipment’s salvage value will increase to the net operating income after 5 years. The machine will pay for itself after 3.4 years. Also, the net present value will remain positively up to a hurdle rate of 18% which is higher than the current cost of capital.
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