Greetings, Inc. - Capital Budgeting

Mary E. Jones
2/27/2011
ACC 560
Week 8: Case 4
Greetings Inc: Capital Budgeting

  1. Calculate the net present value using the numbers provided. Assume that annual cash flows occur at the end of the year.

Initial investment $800,000
Estimated useful life   5 years
Estimated salvage value       -0-

Estimated annual cash flows
Annual cash flow savings for Wall Décor $175,000
Annual additional store cash flow from increased sales   100,000
Sale of ink and paper supplies     10,000
Net annual cash flow $285,000

Present Value
      at 12%
Discount factor for 5 periods 3.60478

Present value of net cash flows
$$285,000 X 3.60478 $1,027,362

12%
Present value of net cash flows $1,027,362
Capital investment     800,000
Net present value $   227,362

  2. Mr. Burns is concerned that the original estimates may be too optimistic. He has suggested that you do a sensitivity analysis assuming all costs are 10% higher than expected and that all inflows are 10% less than expected.

Initial investment $880,000
Estimated useful life   5 years
Estimated salvage value       -0-

Estimated annual cash flows
Annual cash flow savings for Wall Décor $157,500
Annual additional store cash flow from increased sales     90,000
Sale of ink and paper supplies       9,000
Net annual cash flow $256,500

Present Value
      at 12%
Discount factor for 5 periods 3.60478

Present value of net cash flows
$$256,500 X 3.60478 $924,626

  12%
Present value of net cash flows $ 924,626
Capital investment   880,000
Net present value $   44,626

  3. Identify possible flaws in the numbers or assumptions used in the analysis, and identify the risk(s) associated with purchasing the equipment.

One risk would be with the prices of equipment going up and the cash flows going down...