Capital budgeting project - Essay Example

The given project was related to design and estimate the capital budget of Wright Dive Shop, the shop aimed to expand its operations by purchasing a new Air Compressor. The first step of designing the capital budget was to estimate the cash flows of the project, the acceptance and the rejection of the project depends on the analysis of these cash flows. Latterly the strength was judged by using the Payback Period, Net Present Value of the project and the Internal Rate of Return. These three processes are considered to be the capital budgeting rules that help to estimate the strength of the project.

The process of Capital Budgeting was used to determine the cash flows of the purchase. The Initial investment was calculated by adding the purchase price and the investment made to increase the working capital of the business operations. The total initial investment was 425,000 (including the purchase price i.e. 325,000 and the investment in Net Working Capital i.e. 100,000). The depreciation value was identified by using the MACRS- 10 years table (7 year’s values were used). The assumptions were provided in the case and these assumptions were applied to the labor and gas costs.

The labor costs were assumed to increase by 3% till the 3 year, the 4th year increment was 5 % and 7% increment was estimated for the 5th, 6th and 7th year. The Gas costs were assumed to fluctuate at 7% every year till the year 4 and after that the value of increased to 9%. The cash outflows were subtracted from the cash inflows and hence the net cash flows were extracted after deducting the variable and fixed costs and adding back the depreciation of the compressor as it is a non cash item. The cash flows were then used to identify the strength of the investment opportunity.

The payback period was used to identify the number of years in which the project was assumed to pay off the initial investment. The total initial investment was