Objectives:
- Introduce the basic concepts of capital budgeting, including cash flow calculation and decision metrics.
- Determine the cash flows appropriate to consider for a potential project.
- Forecast a project’s cash flows.
- Evaluate a project using payback period, net present value (NPV), and internal rate of return (IRR).
- Raise the issue of how to compare projects with unequal lives.
- Introduce different types of risk inherent in capital budgeting and how they are incorporated into the analysis.
Questions:
- Should the following be included in Sneaker 2013’s capital budgeting cash flow projection? Why or why not? a.Building a factory and purchase/installation of the equipment b Research and development costs c. Cannibalization of other sneaker sales d. Interest costs e. Changes in current asset/current liabilities accounts f. Taxes g. Cost of goods sold h. Advertising and promotion expenses j. Depreciation charges
- Attach an Excel Spreadsheet with:
- Projected cash flows statement for each project.
- Payback,
- IRR, and
- NPV analysis.
- Does Persistence appear attractive from a quantitative standpoint?
- Which project do you think is more risky? How do you think you should incorporate differences in risk into your analysis?
- Which project looks better for New Balance shareholders? Why?
- Should Rodriguez be more or less critical of cash flow forecasts for Persistence than of cash flow forecasts for Sneaker 2013? Why?
- What is your final recommendation to Rodriguez?