# Capital Budgeting

An analyst gathered the following information about a capital budgeting project: The proposed project cost \$10,000 The project is expected to increase pre-tax net income and cash flow by \$3,000 in each of the next 8 years The company has 50% of its capital in equity at a cost of 12% The cost of new debt is 6% The company’s tax rate is 33% What is the project’s net present value???

1546.36

wacc = 0.50*0.06(1-.33)+0.50*0.12= 0.08 N=8, I=8%, PMT=3,000 PV=17,240 NPV = (\$10,000)+ \$17,240 = \$7,240

Well, I got wacc of 8.01%

i was shooting for “good enough for government work” !!!

The answer is 1,551… similar to sayuria answer. How did you get there???

ugh, i instantly realized PMT is \$3,000*0.67 = \$2,010

Tax effect the CFs before calculating the NPV

Right, stupid me, forgot to tax the cash flow:)) gabrielamdea, here: From Char-lee’s calculus: wacc = 0.50*0.06(1-.33)+0.50*0.12= 0.08 use the cash flow worksheet on your calculator, CF0=-10,000 CF1=2010 (that comes from 3000*(1-tax rate) F1=8, Hit NPV and insert 8 as I

gabrielamdea Wrote: ------------------------------------------------------- > An analyst gathered the following information > about a capital budgeting project: > The proposed project cost \$10,000 > The project is expected to increase pre-tax net > income and cash flow by \$3,000 in each of the next > 8 years > The company has 50% of its capital in equity at a > cost of 12% > The cost of new debt is 6% > The company’s tax rate is 33% > > What is the project’s net present value??? PRETAX net income and cash flow = \$3,000 maybe i should apply for the government job…

ohhhhh…you are right!!! got it !!!

stupid me… I was also wondering about the tax on the cash flows. Remember… Capital budgetting decision based on how much the firm get to keep.

I also forgot to tax the cash flow!!! clear now!!!

In all honest, has anyone seen a single question where you tax that cash flow? I haven’t. Have I just seen example where they always give the after tax cash flow amounts? To be a real pain in the butt, wouldn’t you recognize a loss in the first year creating a NOL that would be realizable in the future periods if you were being really correct?!

But it sasys…“The project is expected to increase PRE-TAX net income and cash flow …” so, it’s ok to tax the CF then…

3 critical things for cap budgeting- after tax cash flow, incremental cash flow and opportunity cost.

thx surya

Char-Lee Wrote: ------------------------------------------------------- > wacc = 0.50*0.06(1-.33)+0.50*0.12= 0.08 > > N=8, I=8%, PMT=3,000 PV=17,240 > > NPV = (\$10,000)+ \$17,240 = \$7,240 THIS IS THE FASTEST WAY TO DO IT, OR YOU CAN DO IT ON AN HP12C BY INPUTING 9 CASH FLOWS Y0 = (10,000) AND Y1 - 8 = + 3000 WAC = 8%, I GOT THAT… I LIKE THE WAY ABOVE, IT TREATS IT LIKE A BOND AND IS QUICK THANK YOU!

3000 is wrong… 3000 is before tax cash flow. you need after tax cash flows for capital budgeting. cf0 = -10000 so cf1-8 = 3000 * (1-.33) = 3000 * .67 = 2010. wacc: .5 * 12 + .5 * 6 * (1-.33) = 6 + 2.01 = 8.01 Now calculate the NPV… CP