Q.1.Should the X2-A machine be considered for purchase by the company?

Why Answer: The X2-A machine should be considered for purchase by the
company as

it is faster and efficient than the old version of X2.

Q.2.What are some relevant pieces of information necessary for the decision
to purchase or not to purchase the machine?

Answer: The sale proceeds of the old machinery should have been
mentioned and also its book value, so that exact initial cash outflow could
have been calculated easily.

The income tax rate should also have been given, then the cash flow position
would have been different altogether.

Q.3. Evaluate the economic feasibility of X2-A? Answer: Total income =

17,300

Total cost = (42,000) Net Loss (24,700)

As per the above calculation the X2-A machine is not economically feasible
for the company as it is giving a loss of Rs.24700

Q.4.Should the company purchase the machine? Why or why not? Answer:
Yes, the company should purchase the machine as it is going to benefit

the company in the long run because of its new technology and efficiency.

Q.5.If the company had a list of potential capital expenditure would the X2-
A likely to be on the list?

Answer: Yes, the X2-A would likely to be on the list if the company had to
make capital expenditure because the company urgently needs such capital
expenditure in order to meet its future needs.

Q.6.What factors permit an independent project’s inclusion in the firm’s

capital budget?

Answer: Following are the factors that permit an independent project’s

inclusion in the firm’s capital budget:

1. Higher NPV 2. Higher return on investment

3. New technology 4. Controlled overhead costs 5. Consistent method of

depreciation 6. Efficiency

Q.7.What part does the capital structure play in the capital budgeting
process?

Answer: Capital structure plays a very vital role in the capital budgeting
process as the company mainly raises the required capital from the two parts
of Capital Structure namely Debt and Equity.

Debt is that portion of capital which is raised by the company by issuing

bonds/debentures or by borrowing from the banks and upon which the
company has to pay fixed periodic interest to the bondholders or the
Lenders.

Equity is that portion of capital which is raised by issuing shares and upon
which the company has to bear a cost of equity in the form of
return/dividend on investment for the shareholders

Q.8.Cite as many steps as you can of the capital budgeting process in the
typical manufacturing firm. Would the process differ significantly for
nonmanufacturing firm?
Answer: Capital budgeting steps for manufacturing firm are as follows:

1. Identify the investments project that agree with the organization’s strategy.

2. Gather information from all parts of the value chain to evaluate the
alternate projects

3. Forecast all potential cash flows attributable to the alternative projects

4. Making decisions by choosing the best alternatives among all.

5. Implement the decision and evaluate the performance of the project by

comparing its actual cash flows with the estimated cash flows. For
the nonmanufacturing firm, the steps of capital budgeting wont differ
significantly as the basic steps are the same for both the service and
manufacturing sector.

Q.9.What is the economic rationale for the use of NPV or IRR in capital
budgeting?

Answer: Both IRR and NPV account for the Time Value of Money in their
calculations. This is the economic rationale for the use of NPV and IRR in
the capital budgeting.

Q.10.In capital budgeting, is one discounted cash flow method NPV/IRR

preferable?

Answer: NPV is preferable over IRR because it can handle various discount
rates the long term projects unlike the IRR which uses fixed discount rates
for evaluating the projects.
NPV takes into account the marketing conditions when we are evaluating the
long term projects and the IRR does not.

NPV is more suitable than IRR when we are faced with the mix of cash
flows .i.e. both positive and negative cash flows.

Q.11.What effect would straight-line depreciation have upon NPV of the

X2-A?

Answer: By using straight-line method of depreciation there would not be

any effect on the NPV as the NPV will become so predictable provided the
amount of depreciation would be same every year.

Q.12. In capital budgeting analysis how should risk be defined? Answer:

Risk is a factor which determines that investment project undertaken by

the company will lead to a loss.