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A proposal for the project to implement 5 2. Justification for the Recommendation 5 2. Summary of Other Factors in Capital Budgeting Decision 7 3. Sources of Finance being considered 8 3. A description of equity and debt 8 3. Calculation of NPV, IRR, and Payback Periods for the Two Projects The calculation of NPV, IRR, and Payback Periods for the Two Projects is included in the appendix. The initial step in calculating the NPV, IRR, and the payback periods for the projects is by determining the annual cash flows. The capital cost allowance approach takes place when a firm buys a piece of equipment, a building, or another long-term asset, but is not allowed to deduct the total cost of the particular asset on the income taxes. As supported by Bekaert and Hodrick (2017, p.

rather than deducting the value of the asset from the relevant existing income taxes, the firm is allowed to undertake deduction of the entire cost only for a given period of years. it is the level that a firm is anticipated to pay averagely to its various stockholders in the process of financing its assets (Frank & Shen, 2016 p. This way, it shows the minimum return that a firm should earn using a suitable asset base to satisfy its shareholders, lenders, other stakeholders who provide capital. Notably, the \$120,000 used in the market research was not included in the WACC analysis. The primary rationale for this assertion is that the cost of market research is embraced as a sunk cost. These costs are costs that have already been born and cannot be recovered.

The summary can be shown in a table as follows: Project Project Aspire Project Wolf NPV (\$) 159,172 838,145 IRR (%) 12. Payback Period (Years) 3. Based on the results presented above, it is evident that Project Wolf is more profitable relative to Project Aspire. For instance, with basis on the NPV, project Wolf has a higher NPV than Project Aspire. Further, its payback period is shorten than that of Project Aspire. should take the project with the highest positive NPV. The other rationale for the recommendation of undertaking Project Wolf is based on the (internal rate of return) IRR criterion. The IRR is applied in estimating the profitability of a project. From a general perspective, the higher a project’s IRR, the more profitable it is.

Further, the application of the IRR indicates that it omits external variables including the cost of capital. p. this condition occurs where there is the distinction in cash flow patterns such as where a project might have high amounts of cash flows in the initial phases relative to the other project (Götze et al. p. In resolving this form of discrepancy, the project with a high NPV should be selected based on the concept that it engages the aspect of reinvestment and more accuracy levels. The other criterion which justifies the selection of Project Wolf is the Payback Period. The firm should also undertake an appropriate analysis of the impact of the selected project to the firm’s existing productions.

The rationale for this suggestion is that there are cases when new products end up negatively affecting the sales of existing items (Andor et al. p. If this situation is evident, then it should be taken into consideration. The company should also verify if the figures utilized in the analysis were accurate and correct. It can also decide to borrow finances from financial institutions such as banks or raise funds by issuing new shares. This section describes the types of financing that AYR Co. can use to finance the selected project. A description of equity and debt Funding through the use of equity is recognized as raising finances by issuing the firm’s new shares. In case the organization has shares that have not been provided to the stockholders, then it can issue the stocks to obtain funds required to fund a project.

This is because the common shareholders are paid when all other external lenders have fully been compensated for their investment in the company. Also, interest payments are needed by the law to pay irrespective of the amount of income or sales for the firm. However, an organization is not legally bound to make dividend declarations each time (Sharan, 2015 p. As a result, it may end up not declaring dividends so that the earnings are reinvested in the firm. This shows how the cost of equity is riskier than the value of debt. However, it can end up diluting existing shareholders’ wealth. This is because the firm’s net income is shared among multiple shares. When the firm raises finances by equity funding, there exists a desirable component in cash flows on financing activities segment and a rise of common shares using the par values in the statement of the firm’s financial position.

If the organization raises its finances by debt funding, there exists a desirable component in the financing segment of the cash flow statement and a rise in liabilities on the statement of financial position. This is because debt funding entails a principal, that should be repaid to the bondholders and creditors, alongside accumulated interest. Borrowing funds are often associated with covenants which should be followed to additional sanctions as well as penalties. Irrespective of the financial performance of a firm, it is still required to pay the principal borrowed together with interest payments. As demonstrated earlier on, the financial statements of the firm would depict a positive growth. The statement of financial position would also demonstrate a rise in the firm’s total liabilities and a significant decline in its net income because of making interest payments to the lenders and creditors.

Conclusion In conclusion, it is evident that the organization should factor in certain variables before deciding on the project to undertake, especially where projects are mutually exclusive. All in all, AYR Co. should implement Project Wolf because it is more desirable than Project Aspire. References Andor, G. Mohanty, S. K. C. Nason, R. R. and Gessaroli, J. Financial Management: Theory and Practice, Canadian Edition. Götze, U. Northcott, D. and Schuster, P. Discounted Cash Flow Methods. In Investment Appraisal (pp. June quarter, pp. Magalhães, P. and White, K. G. The effect of a prior investment on choice: The sunk cost effect. PAYBACK PERIOD 3. years PROJECT WOLF Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Cash Inflows \$955,000 \$955,000 \$955,000 \$955,000 \$955,000 Material Costs \$14,400 \$15,480 \$16,641 \$17,889 \$19,231 Other Expenses \$18,000 \$16,650 \$15,401 \$14,246 \$13,178 Foregone Rental Income \$75,000 \$75,000 \$75,000 \$75,000 \$75,000 Depreciation Expenses   \$375,000 \$375,000 \$375,000 \$375,000 \$375,000 EBIT \$472,600 \$472,870 \$472,958 \$472,865 \$472,592 Taxes (20%)   \$94,520 \$94,574 \$94,592 \$94,573 \$94,518 Net Income \$378,080 \$378,296 \$378,366 \$378,292 \$378,073 Add: Depreciation \$375,000 \$375,000 \$375,000 \$375,000 \$375,000 Operating Cash flow   \$753,080 \$753,296 \$753,366 \$753,292 \$753,073 Salvage Value \$375,000 Capital Spending \$(2,250,000) Cash Flow \$(2,250,000) \$753,080 \$753,296 \$753,366 \$753,292 \$1,128,073 Discount Factor 1.