Capital Budgets

FIN401A01

Argosy University

June 21, 2014

This report will evaluate Wheel Industries on their procedures involving long-term investment opportunities providing a detailed illustration of the use of several techniques for evaluating capital projects, including the Weighted Average Cost of Capital to the firm, the anticipated cash flows for the projects and the methods used for project selection. The report will also include evaluations of two other projects in detail concerning the risk of future investments.

Scenario: Company Information

Wheels Industries is considering a three-year expansion project, Project A. The project requires an initial investment of $1.5 million. The project will use the straight-line depreciation method. The project has no salvage value. It is estimated that the project will generate additional revenues of $1.2 million per year before tax and has additional annual costs of $600,000. The Marginal Tax rate is 35% (Argosy, 2014).

We start by finding the Depreciation of this project, so in order to obtain this we will use the formula: Depreciation = Cost of the asset – salvage value/ Life of the asset.

We know that we have no salvage value, so we divide the cost of asset by life of the asset.

D =1,500,000/ 3

D = 500,000

The depreciation is 500,000 per year.

The next step is to do a calculation of Cash flows:

Revenue- 1,200,000

Less Cost- 600,000

Less Depreciation- 500,000

Profit- 100,000 (income before taxes)

Less taxes (35%) 35,000

Profit after taxes 65,000

Add depreciation 500,000

Cash flow after taxes 565,000

The calculation of Cash flow states that after taxes, Wheel Industries will have $565,000 cash flow.

Wheel has paid a dividend of $2.50 per share, which is expected to grow at a constant rate of 6% per year for the life of the stock. The stock is currently selling for $50 per share with a 10% floatation cost. This will give the...