How do i solve a capital budgeting topic? with the new investment thingy? thanks!?

how do i solve a problem in capital investment? with some sort of replacing the equipment with a new one so i should get the new cash outlay of the company. thanks!

At the heart of any capital budgeting issue is finding out the Net Present Value of the project. If the NPV>0, you would accept the project. Decline those projects with NPV<0.

You'll need
鈥?discount rate
鈥?tax rate
鈥?growth rate of incoming cash flows
鈥?depreciation schedule


Step 1: Incoming Cash Flows (this is given, and projected according to the average of growth rates between years)

Step 2: Depreciation, usually as a % of the machine's value

Step 3: Operating Income, difference between the incoming cash flow of the machinery and the depreciation level found in step 2.

Step 4: Taxes = Operating Income x Tax Rate

Step 5: Operating Income - Taxes = Net Income

Total Cash Flow= Net Income + Depreciation

Step 6: Residual Value, in whichever year the machinery is sold depreciation doesn't need to be calculated.

Step 7: Discount Total Cash Flows at the hurdle rate (what return are you looking for from the investment?) The formula for each period's Total Discounted Cash Flow is X/[(1+r)^n] where X is the Total Cash Flow, r is the hurdle rate, and n is the time period. Sum each of these expressions to find the PV of the project.

Initial Amount Invested - PV = NPV

To include the effect of replacing machinery, you should repeat steps 1-2a, and add the operating income received from the new machine to step 5 above. Don't forget to add the residual value of this new machinery at the end of the forecast period in the same way discussed in step 6.