2/27/2011

ACC 560

Week 8: Case 4

Greetings Inc: Capital Budgeting

1. Calculate the net present value using the numbers provided. Assume that annual cash flows occur at the end of the year.

Initial investment $800,000

Estimated useful life 5 years

Estimated salvage value -0-

Estimated annual cash flows

Annual cash flow savings for Wall Décor $175,000

Annual additional store cash flow from increased sales 100,000

Sale of ink and paper supplies 10,000

Net annual cash flow $285,000

Present Value

at 12%

Discount factor for 5 periods 3.60478

Present value of net cash flows

$$285,000 X 3.60478 $1,027,362

12%

Present value of net cash flows $1,027,362

Capital investment 800,000

Net present value $ 227,362

2. Mr. Burns is concerned that the original estimates may be too optimistic. He has suggested that you do a sensitivity analysis assuming all costs are 10% higher than expected and that all inflows are 10% less than expected.

Initial investment $880,000

Estimated useful life 5 years

Estimated salvage value -0-

Estimated annual cash flows

Annual cash flow savings for Wall Décor $157,500

Annual additional store cash flow from increased sales 90,000

Sale of ink and paper supplies 9,000

Net annual cash flow $256,500

Present Value

at 12%

Discount factor for 5 periods 3.60478

Present value of net cash flows

$$256,500 X 3.60478 $924,626

12%

Present value of net cash flows $ 924,626

Capital investment 880,000

Net present value $ 44,626

3. Identify possible flaws in the numbers or assumptions used in the analysis, and identify the risk(s) associated with purchasing the equipment.

One risk would be with the prices of equipment going up and the cash flows going down...