Capital BudgetingAs business owners, we constantly strive to ensure the profitability of our company byworking hard to generate a high rate of return on both short and long term investments.In chapter 7 we discussed how we manage working capital to maintain liquidity and tomeet our short-term obligations. We pointed out that excess cash should be investedtemporarily in short-term marketable securities to generate a more positive return on ourinvestment without too much risk. We also mentioned that we invest in assets that areexpected to result in cash returns for a period of 1 year or more. These investments incapital expenditures (assets having a useful life of 1 year or more) are expected to helpgenerate increased revenues that make our firm more profitable in the future. Ourbusiness must constantly make decisions about whether to purchase new equipment orexpand operations with the addition of new buildings. The method we use to make thesedeterminations is referred to as capital budgeting.Please read the accompanyinginformation about Northeast Studios. This company has experienced tremendous growthin the past few years and is nearing the capacity of their two current recording facilities.Northeast Studios is considering expanding the company and purchasing a turnkeystudio facility, Studio C from their current competitor.Northeast Studios is in the process of deciding whether or not to expand and purchaseStudio C from their competitor, Noah Gigliotti. If Northeast would purchase Studio C, itwould cost $400,000 at the time of the purchase. Northeast is projecting that the newfacility will be able to generate an additional $100,000 in positive cash flow per year forfive (5) years.Northeast Studios will use a collateralized equipment loan to finance the expansion. Thecompany has been approved to for a $300,000, five-year loan at an 8% annual interestrate from Chase Manhattan that will start on January 1, 2011 and will be paid off byDecember 31, 2015. To finance the remaining $100,000, Northeast will divert cash fromtheir savings at an opportunity cost of 4%.The facilitys David Smith Massenberg GML Console is valued at $210,000 and has anestimated salvage value of $60,000 after its five (5) year depreciable lifespan. The otherrecording equipment has an estimated value of $90,000 with a three (3) yeardepreciable lifespan and no ($0) salvage value. The building has an estimated value of$100,000 and a 25-year depreciable lifespan and an assumed $0 salvage value.1WEEK 3 | 10%Capital BudgetingPlease answer the following questions:1. (a) Using the straight-line method, calculate the annual depreciation for each of thefollowing three assets: The Massenberg GML Console, the other recordingequipment, and the building. (b) What is the total annual depreciation for the firstyear? 30,000 for console.2. (a) Using an amortization schedule calculator, calculate the annual interest expense forthe equipment loan obtained from Chase Manhattan beginning on January 1, 2011 foreach of the five years of the loan. (b) Explain the difference between the interestexpense and the loan payments made to the bank for each year of the loan.3. Using the payback method, determine the length of time that will be required to recoupthe $400,000 investment in the new facility.4. Calculate the companys Weighted Average Cost of Capital using the loan and the cashfrom savings to finance the expansion.5. (a) Calculate the net present value of the investment in the new facility. (b) Calculate theprofitability index of the investment. (c) Should Northeast Studios proceed with theinvestment? Why or why not?6. Suppose the companys weighted average cost of capital rose 3% higher than the ratethat was originally calculated in question #5. (a) Calculate the net present value and (b)profitability index using the revised cost of capital. (c) Should Northeast Studios stillproceed with the investment? Why or why not?7. Explain the relationship between the net present value and the profitability index.8. (a) Calculate the accounting rate of return. (b) What are the advantages anddisadvantages of this type of calculation?9. Identify and explain some of the specific assets that YOUR OWN Company will need toown in order to operate in the capacity you have assumed, to have the capability toproduce its products or services, or otherwise make those products or services availablefor sale. In other words, what assets (equipment) will your company need?10. From Rich Dad, Poor Dad, what is Rich Dads Rule One? Why is it so important?Capital BudgetingIMPORTANT REMINDER: This is an individual assignment. Students are required touse their own language when writing papers or other assignments. Plagiarism is usinganother authors words or language without putting those words in quotation marks andfailing to give proper credit to the author. Plagiarism also includes changing the wordsfrom a third party source while maintaining the same sentence structure and notproviding proper citation and reference. Consult your course syllabus for more details.Infractions regarding plagiarism will result in a grade of zero for the assignmentand disciplinary action, which may include failure of and repayment for thecourse, suspension or expulsion.
