Learning Team A Capital Budget Recommendation
Gerald Shaw, Kenneth Barre, Rosa Daws
February 23, 2015
Learning Team Weekly Reflection Week 2
For this week’s assignment Learning Team A will be providing insight on the three capital budgeting techniques in relation to the Guillermo Furniture Scenario. Learning Team A after careful evaluation of the data sheets provided for Guillermo Furniture will identify the best uses for the three techniques and lastly provide a capital budget recommendation that best suites Guillermo Furniture.
Three Capital Budget Evaluation Techniques-Gerald
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IRR (Internal Rate of Return)
The IRR (internal rate of return) method helps to identify the discount rate for the projects NPV equaling zero (Eldenburg, PhD & Wolcott PhD, CPA, CMA, 2011). Using this method the calculation like NPV is based on discounted cash flows; it’s a difference of assuming in the NPV calculation versus locating the discount rate that gives the NPV a zero result. This method can at times be more time consuming in comparison to NPV and IRR shows that the cash inflows hold the ability to be reinvested to reach the same return rate (Eldenburg, PhD & Wolcott PhD, CPA, CMA, 2011).
The payback method is just that by helping to identify the time it will take to recover the initial investment (Eldenburg, PhD & Wolcott PhD, CPA, CMA, 2011). The calculation for this method an expectant of the projects cash flows staying constant in the years coming; by dividing the initial investment by the annual incremental operating cash flow (Eldenburg, PhD & Wolcott PhD, CPA, CMA, 2011). While this method is simple by nature, it also works better in partnership with either NPV or IRR to identify risks to the business.
Best use for the Different Capital Budget Techniques-Ken
To begin the analysis of the two options, a closer look at the data was necessary. Errors committed by the previous accountant were corrected, and several assumptions were also made to ensure the data was realistic. A list of corrections and assumptions is included on the attached data sheet.
Based on the assumptions, and the data provided by Guillermo’s accountant, the High-tech option required a $4,500,000 initial investment for a building and equipment, and we assumed the Broker option would require a $500,000 investment for the building. Because the available cash at the end of 2014 was less than $200,000, we assumed both investments would require financing. We assumed the 7.5% interest rate, which equals that of the current mortgage. As with previous equipment, we assumed a 10-year life and loan term for the equipment.
The analysis reported positive cash flows for the 10-year period for both options. However, a Net Present...