Capital Budgeting Individual Project Assignment

Capital Budgeting Individual Project - Assignment Example Strategic planning is important to the future success of a business enterprise. Capital budgeting is one of the ways that can help a company achieve its long term success through proper planning. Lack of good road map that a strategic plan provides, may lead to misallocation of company resources through addressing short-term issues. This would in turn compromise the long term needs of the company. Necessary Information Sparklin Automotive Company (SAC) has been a successful company within the automotive manufacturing industry, operating since the last eight decades. The company has come up with an innovative idea to launch a new spark plug which offers an enhanced mileage to vehicles i.e. up to 100,000 miles. In order to initiate the new spark plug production, the company needs to set up a new manufacturing plant which would need to be analyzed financially in order to consider it viable for SAC. The entire setup would require information pertaining to the cash inflows and the cash ou tflows that would occur as a result of carrying out the production of the new spark plugs. The financial information that would be needed should only include the relevant costs that would only be attributed as a result of carrying out the new spark plug production. ... owing data would be used to evaluate the capital project: The new spark plug plant would need an initial investment of $1 billion in 2013, which would further be followed by another $500 million investment in 2014. The cash inflows that are expected as a result of this investment are: $300 million (2015), $350 million (2016), $385 million (2017), $400 million (2018), $450 million (2019), and $500 million (2020). All of these expected inflows are considered to be after-tax inflows. It is also expected that the new plant would not attract any Capital Gains; hence no tax savings would be gained. SAC’s current cost of capital is 10%. Capital budgeting The firm’s senior financial officers are faced with two important tasks in a firm. One of the tasks is to make decisions for improving the company’s return on equity. The other task is to find adequate funds for investment opportunities that may arise (Dayananda, 2002). Capital budgeting is the process in which a busine ss management determines whether projects such as long-term investment or building a new plant are worth undertaking. Basically, business should pursue all opportunities and projects that will increase shareholder’s value. However, because of limited nature of capital available for new projects, management needs to implement capital budgeting techniques to determine which will result to high return on a given period of time. Weighted Average Cost of Capital (WACC) Weighted Average Cost of Capital is the calculation of a firm’s cost of capital that involves proportionate weighting of each and every category of capital. When calculating the firm’s weighted average cost of capital, all capital stock such as preferred stock, common stock, bonds, and any other long-term debt are all included. The formula