Today, I received my first capital budgeting assignment and tutoring session for the semester. Capital budgeting is simply finding out if a project will grow a business or not. This may be done through calculating the NPV, IRR, or using the discounted payback method. the reason capital budgeting is so challenging is because of all of the calculations needed to solve the problem. For example, in some problems, the W ACC must be calculated, revenues and costs are not always explicit, and depreciation may be done using different methods. From this, students are definitely mystified by the complexity of the problems.

Sample Capital Bugeting Problem:

A company is considering a project that requires an initial investment of $24M to build a new plant and purchase equipment. The investment will be depreciated as a MACRS 7-year class (see p. 21 in the text) asset. The new plant will be built on some of the company's land which has a current, after-tax market value of $4.3M. The company will produce units at a cost of $130 each and will sell them for $420 each. There are annual fixed costs of $0.5M. Unit sales are expected to be 150,000 each year for the next 6 years, at which time the project will be abandoned. At that time, the plant and equipment is expected to be worth $8M (before tax) and the land is expected to be worth $5.4M (after tax). To supplement the production process, the company will need to purchase $1M worth of inventory. That inventory will be depleted during the final year of the project. The company has $100M of debt outstanding with a yield-to-maturity of 8%, and has $150M of equity outstanding with a beta of 0.9. The expected market return is 13% and the risk-free rate is 5%. The company's marginal tax rate is 40%. Should the project be accepted?

Sample Capital Bugeting Problem:

A company is considering a project that requires an initial investment of $24M to build a new plant and purchase equipment. The investment will be depreciated as a MACRS 7-year class (see p. 21 in the text) asset. The new plant will be built on some of the company's land which has a current, after-tax market value of $4.3M. The company will produce units at a cost of $130 each and will sell them for $420 each. There are annual fixed costs of $0.5M. Unit sales are expected to be 150,000 each year for the next 6 years, at which time the project will be abandoned. At that time, the plant and equipment is expected to be worth $8M (before tax) and the land is expected to be worth $5.4M (after tax). To supplement the production process, the company will need to purchase $1M worth of inventory. That inventory will be depleted during the final year of the project. The company has $100M of debt outstanding with a yield-to-maturity of 8%, and has $150M of equity outstanding with a beta of 0.9. The expected market return is 13% and the risk-free rate is 5%. The company's marginal tax rate is 40%. Should the project be accepted?