Capital Budgeting Frank Smith Plumbing Depreciable Value 215

Capital Budgetingfrank Smith Plumbingdepreciable Value 215000data N

Calculate the payback period, discounted payback period, net present value, internal rate of return, and profitability index for a truck investment project undertaken by Frank Smith Plumbing. Given data include the initial investment, projected earnings before tax and depreciation, depreciation rates, cost of capital, tax rate, and projected cash flows over an eight-year span. Provide a comprehensive analysis of whether Frank should proceed with the project based on these financial metrics.

Paper For Above instruction

In evaluating the financial feasibility of capital investments, businesses utilize various financial metrics to inform decision-making. For Frank Smith Plumbing's proposed truck acquisition, a detailed capital budgeting analysis involving payback period, discounted payback period, net present value (NPV), internal rate of return (IRR), and profitability index (PI) is essential to determine the project's viability. This paper discusses these metrics in detail, applies them to the provided data, and offers a reasoned conclusion on the project's appropriateness.

Introduction

Capital budgeting involves assessing potential investments or projects to allocate resources effectively. In the context of Frank Smith Plumbing, the investment in a new truck and attached equipment necessitates such an analysis to ensure that the project aligns with the firm's financial goals and provides value. The decision hinges on multiple factors, including cash flow projections, depreciation, tax implications, and discount rates. The following analysis integrates these components to appraise whether the proposed purchase should be undertaken.

Financial Data and Assumptions

The project involves acquiring a truck valued at $200,000 and additional equipment costing $15,000, totaling an initial capital outlay of $215,000. The project's lifespan is nominally seven years, but it will be treated as a five-year MACRS property for depreciation purposes, with depreciation rates specified for each year. The company’s cost of capital is 12%, and the corporate tax rate is 35%. The project's annual pre-tax earnings before depreciation are provided across eight years, with depreciation expenses calculated via MACRS percentages. The projected cash flows are adjusted for taxes and depreciation to produce annual net cash flows, critical for the analysis.

Depreciation and Cash Flow Calculation

Utilizing MACRS depreciation rates for five-year property, the depreciation expenses are as follows: Year-1: $43,000, Year-2: $80,000, Year-3: $28,000, Year-4: $72,500, Year-5: $72,500, Year-6: $47,000, with Years-7 and 8 depreciation at zero. The projected earnings before tax and depreciation and their tax impacts are computed annually. The taxes are derived as the product of taxable income and the tax rate, and net earnings are adjusted for depreciation to arrive at annual cash flows. These cash flows serve as inputs for the valuation metrics.

Payback Period Analysis

The payback period indicates how long it takes for the initial investment to be recovered from cumulative cash inflows. The project's payback period, calculated as approximately 3.17 years, suggests that the investment recovers its initial outlay before the end of Year 4, which is within a reasonable timeframe for many capital projects. This metric alone, however, does not account for the time value of money or the profitability of the investment.

Discounted Payback Period (DPB)

The Discounted Payback Period accounts for the time value of money by discounting future cash flows at the company's cost of capital (12%). The calculated DPB of roughly 3.59 years indicates the time it takes for discounted cash inflows to cover the initial investment. Although slightly longer than the simple payback period, it still reflects a relatively quick recovery, favoring project acceptance.

Net Present Value (NPV)

NPV measures the absolute value added by the project, summing the present values of all future cash flows minus initial investment. The computed NPV of approximately $28,682 suggests that the project is expected to generate value beyond the required rate of return. A positive NPV is a key indicator that the project is financially worthwhile and enhances shareholder value.

Internal Rate of Return (IRR)

IRR identifies the discount rate at which the NPV becomes zero. In this analysis, the IRR is approximately 12%, aligning with the company’s cost of capital. Since the IRR equals the required rate of return, the project is considered marginally acceptable; any IRR above this rate would favor project adoption.

Profitability Index (PI)

The profitability index of 1.68 indicates that for every dollar invested, the project returns $1.68 in present value terms. A PI greater than 1 confirms a profitable project, reinforcing the recommendation to proceed.

Decision and Recommendations

Based on the analysis, the project exhibits a quick payback period, positive NPV, IRR aligned with the cost of capital, and a profitability index exceeding one. These metrics collectively suggest that the investment in the truck and equipment will contribute positively to Frank Smith Plumbing’s financial health. The project’s payback period of about 3.17 years is reasonable, especially considering the project's overall profitability and value creation potential.

Therefore, it is advisable for Frank Smith Plumbing to proceed with purchasing the truck, as the project aligns with the firm’s financial objectives and risk tolerance. The investment not only recovers costs relatively quickly but also adds tangible value, making it a sound strategic decision.

Conclusion

Effective capital budgeting ensures that firms make investments that maximize value while minimizing risks. In this case, all pertinent financial metrics—payback period, discounted payback, NPV, IRR, and PI—support proceeding with the truck purchase. The positive value addition, coupled with acceptable investment recovery timelines, warrants approval of the project, contributing to the company’s operational efficiency and profitability.

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