# Capital Budgeting Decisions for a Manufacturing Company

## Summary of information provided

The table presented below shows a summary of information that will be used in the succeeding calculations.

## A statement showing incremental cash flow of the project

The incremental cash flow is arrived at by deducting the total cash outflow from the total cash inflow (Shapiro, 2005). The table presented below shows the computation of the incremental cash flow.

*First part of the table (year 0 – 4)*

*Continuation of the table (year 5 – 8)*

The last row of the two tables shows the net incremental cash flow for each year. The total incremental cash flow for the project is $2,554,375.

## Payback period

The capital decision analysis tool gives the duration of time that the business will take to recover the initial cost of investment. This tool of analysis is significant for the ranking of projects (Hansen, Mowen, & Guan, 2009). A project with a shorter payback period is often preferred.

Payback period = Net cash inflows / initial investment

= $ 4,254,375 / $1,500,000

= 2 years and 10 months

Based on the calculations, the payback period of the project is

## Net present value

The net present value method will involve the selection of a rate acceptable to the management or that equals the cost of finance. The net present value is obtained by deducting the present value of cash outflow from the present value of cash inflow (Siddiqui, 2005). If the NPV is positive, the decision should be to invest in the project but if negative, the decision should be to avoid the project (Steven, 2007). The table presented below shows the calculations for the net present value.

*The first part of the table (year 0 – 4)*

*Continuation of the table (year 5 – 8)*

From the calculations present above, the net present value of the new product line is $1,111,351.05.

## Making a decision based on the calculations above

Based on the calculations above, the project has a shorter payback period of 2 years and 10 months than the policy of the company (3 years). Further, the project yields a positive net present value of $1,111,351.05. Thus, the project should be accepted since it yields positive returns and the investors will be able to recover the initial cost of investment within a short period (Shim, & Joel, 2008). An additional investment in land and building will affect the net present value and the payback period. If the additional investment lengthens the payback period and the NPV turns negative, then the project will no longer be financially viable.

## References

Hansen, R., Mowen, M., & Guan, L. (2009). *Cost management: accounting & control*. USA: South Western Cengage Learning.

Shapiro, A. (2005). *Capital budgeting and investment analysis*. India: Pearson Education India.

Shim, J., & Joel, S. (2008). *Financial management*. New York: Barron’s Educational Series, Inc.

Siddiqui, A. (2005). *Managerial economics and financial analysis*. New Delhi: New Age International (P) Limited.

Steven, B. (2007). *Financial analysis a controllers guide: Financial analysis. *New York: John Wiley & Sons.