What is capital rationing?
Method of awarding capital in most profitable way among the different project is called capital rationing.
Capital rationing may be a well-thought-out approach utilized by businesses to confine the number of projects they take on at any given moment, permitting proprietors and administration to aim for strong and profitable activities, permitting them to produce superior benefits inside a restricted capital budget.
The practice of assessing and selecting among potential capital projects depending on the accessibility of cash is known as capital rationing. Capital rationing happens when a company's cash accessible to spend on long-term resources is confined. Managers must choose whether and when to create certain capital investments.
Using NPV to make capital investment decisions Holmes Industries is deciding whether to automate one phase of its production process. The manufacturing equipment has a six-year life and will cost $910,000.
Year 1 $ 262,000
Year 2 254,000
Year 3 222,000
Year 4 215,000
Year 5 200,000
Year 6 175,000
Holmes could refurbish the equipment at the end of six years for $104,000. The refurbished equipment could be used one more year, providing $77,000 of net cash inflows in year 7. Additionally, the refurbished equipment would have a $55,000 residual value at the end of year 7. Should Holmes invest in the equipment and refurbish it after six years? (Hint: In addition to your answer to Requirement 1, discount the additional cash outflow and inflows back to the present value.)
Use the NPV method to determine whether Hawkins Products should invest in the
• Project A: Costs $285,000 and offers seven annual net cash inflows of $55,000. Hawkins Products requires an annual return of 14% on investments of this nature.
• Project B: Costs $395,000 and offers 10 annual net cash inflows of $77,000. Hawkins Products demands an annual return of 12% on investments of this nature.
1. What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
2. What is the maximum acceptable price to pay for each project?
3. What is the profitability index of each project? Round to two decimal places.
Hill Company operates a chain of sandwich shops. The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of$8,700,000. Expected annual net cash inflows are $1,550,000 for 10 years, with zeroresidual value at the end of 10 years. Under Plan B, Hill Company would open threelarger shops at a cost of $8,340,000. This plan is expected to generate net cash inflowsof $990,000 per year for 10 years, the estimated useful life of the properties. Estimatedresidual value for Plan B is $1,200,000. Hill Company uses straight-line depreciationand requires an annual return of 10%.
1. Compute the payback, the ARR, the NPV, and the profitability index of thesetwo plans.
2. What are the strengths and weaknesses of these capital budgeting methods?
3. Which expansion plan should Hill Company choose? Why?
4. Estimate Plan A’s IRR. How does the IRR compare with the company’s requiredrate of return?
Splash Nation is considering purchasing a water park in Atlanta, Georgia, for $1,910,000. The new facility will generate annual net cash inflows of $483,000 foreight years. Engineers estimate that the facility will remain useful for eight years andhave no residual value. The company uses straight-line depreciation, and its stockholdersdemand an annual return of 10% on investments of this nature.
1. Compute the payback, the ARR, the NPV, the IRR, and the profitability index ofthis investment.
2. Recommend whether the company should invest in this project.
94% of StudySmarter users get better grades.Sign up for free