Capital Budgeting Case Essay

495 WordsSep 16, 20142 Pages
Capital Budgeting Case Virginia Sacco University of Phoenix Quantitative Reasoning for Business QRB 501 Li Guohong March 10, 2014 Capital Budgeting Case My company is contemplating to acquire another corporation, “Corporation A” or “Corporation B” on a $250,000 budget. Corporation A: Revenues = $100,000 in year one, increasing by 10% each year. Expenses = $20,000 in year one, increasing by 15% each year/ Depreciation expense = $5,000 each year. Tax rate = 25%. Discount rate = 10%. Corporation B: Revenues = $150,000 in year one, increasing by 8% each year. Expenses = $60,000 in year one, increasing by 10% each year/ Depreciation expense = $10,000 each year. Tax rate = 25%. Discount rate = 11%. The Net Present Value (NPV) of an investment proposal is equal to the present value of its annual free cash flows less the investment’s initial outlay (Keown, A. J., Martin, J. D., & Petty, J. W. (2014). The rule here is that our company will accept projects with a net present value greater than zero, and decline the ones with a net present value that is less than zero. The greater the net present value, the more appropriate the investment is. Based on that, Corporation B is desirable to Corporation A as it has a greater net present value. The Internal Rate of Return (IRR) is defined as the discount rate that equates the present value of the project’s free cash flows with the project’s initial cash outlay (Keown, A. J., Martin, J. D., & Petty, J. W. (2014). Based on the Internal Rate of Return rule, an investment is suitable if the Internal Rate of Return exceeds the required return, it should be rejected otherwise. Based on that, Corporation B is preferred over Corporation A since the former has a higher Internal Rate of Return. Examining the above, the Net Present Value and the Internal Rate of Return are closely related.

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