# Question

Comprehensive problem—quantitative and qualitative analysis The following data have been collected by capital budgeting analysts at Sunset Beach, Inc., concerning an investment in an expansion of the company’s product line. Analysts estimate that an investment of $150,000 will be required to initiate the project at the beginning of 2013. The estimated cash returns from the new product line are summarized in the following table; assume that the returns will be received in a lump sum at the end of each year:

Amount of

Year Cash Return

2013 . . . . . . . . . . . . . . . . . . . . . . . . . $40,000

2014 . . . . . . . . . . . . . . . . . . . . . . . . . 50,000

2015 . . . . . . . . . . . . . . . . . . . . . . . . . 64,000

2016 . . . . . . . . . . . . . . . . . . . . . . . . . 46,000

The new product line will also require an investment in inventory and receivables of $50,000; this investment will become available for other purposes at the end of the project. The salvage value of machinery and equipment at the end of the product line’s life is expected to be $25,000. The cost of capital used in Sunset Beach, Inc.’s, capital budgeting analysis is 12%.

Required:

a. Calculate the net present value of the proposed investment. Ignore income taxes and round all answers to the nearest $1.

b. Calculate the present value ratio of the investment.

c. What will the internal rate of return on this investment be relative to the cost of capital? Explain your answer.

d. Calculate the payback period of the investment.

e. Based on the quantitative analysis, would you recommend that the product line expansion project be undertaken? Explain your answer.

f. Identify some qualitative factors that you would want to have considered with respect to this project before management proceeds with the investment.

Amount of

Year Cash Return

2013 . . . . . . . . . . . . . . . . . . . . . . . . . $40,000

2014 . . . . . . . . . . . . . . . . . . . . . . . . . 50,000

2015 . . . . . . . . . . . . . . . . . . . . . . . . . 64,000

2016 . . . . . . . . . . . . . . . . . . . . . . . . . 46,000

The new product line will also require an investment in inventory and receivables of $50,000; this investment will become available for other purposes at the end of the project. The salvage value of machinery and equipment at the end of the product line’s life is expected to be $25,000. The cost of capital used in Sunset Beach, Inc.’s, capital budgeting analysis is 12%.

Required:

a. Calculate the net present value of the proposed investment. Ignore income taxes and round all answers to the nearest $1.

b. Calculate the present value ratio of the investment.

c. What will the internal rate of return on this investment be relative to the cost of capital? Explain your answer.

d. Calculate the payback period of the investment.

e. Based on the quantitative analysis, would you recommend that the product line expansion project be undertaken? Explain your answer.

f. Identify some qualitative factors that you would want to have considered with respect to this project before management proceeds with the investment.

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