Capital Budgeting Case
Shawn P. Oeser
October 7, 2013
Capital Budgeting Case
For the final week of QRB/501 we were asked to complete a Capital Budgeting Case based on two possible corporations for our company. Based on the 5 year projected income statement, 5 year projected cash flow, Net Present Value (NPV), and Internal Rate of Return (IRR); we were to determine which company would be the wiser acquisition. After completing the analysis it was determined that Corporation B would be the proper choice of the two corporations.
According to our text the NPV, “of an investment proposal is equal to the present value of its annual free cash flows less the investment’s initial outlay” (Keown, Martin, & Petty, 2014, p. 310), therefore determining the NPV value of each company is a step needed in determining the whether either company was worth the initial investment. The next step was determining the companies IRR, ...view middle of the document...
Since both companies had a positive NPV they are both worthwhile companies for acquiring, but with the higher NPV of Corporation B , this makes it the company with the better rewards.
The area that clinched Corporation B as the company to purchase was the IRR. With and IRR of 17% for Corporation B compared to the 13% for Corporation A, Corporation B was the logical choice. Based on the Capital budgeting the higher the IRR value, again the better choice for moving forward with an acquisition or purchase is advised. The information we were not given was our companies desired IRR percentage rate which would have given a better idea of which company would fit the companies IRR better.
By looking at the NPV and IRR we can determine if an acquisition, be it a company or a piece of equipment for a company, it can determine whether the acquisition is a good idea or not. For the purpose of this particular Capital Budgeting Case study it was clear that Corporation B is the corporation for our company to purchase, with a higher NPV and IRR Corporation B is the best acquisition.
The relationship of the NPV and IRR must both be looked at, since an IRR alone does not show if the NPV is positive, you must look at the two together. While the IRR is usually compared to a companies required rate of return, without looking at the NPV the IRR percentage could give a false belief that the project or acquisition is a good deal. If you have a negative NPV you should not move forward, regardless of the IRR. Yet if you have a positive NPV and a favorable IRR then a company should move ahead with the project or acquisition. The final deciding factor between these two companies was actually the discount rate. With Corporation A having a 10% discount, and Corporation B having an 11% discount, the number swayed to Corporation B. Had the discount been the same for both companies then Corporation A would have actually been the better acquisition.
Keown, A. J., Martin, J. D., & Petty, J. W. (2014). Foundations of Finance: The Logic and
Practice of Financial Management (8th ed.). Upper Saddle River, New Jersey: Pearson Education, Inc..