The group of employees that submitted this request is disappointed that you provided a "reject" recommendation for its proposal. The group does not understand why working capital is treated as a $100,000 cash outflow now and a $100,000 cash inflow at the end of the project. To explain your accounting for working capital in the NPV analysis shown above, you decide to proceed in two steps. First, you will explain how to calculate the annual opportunity costs that arise from tying up $100,000 of working capital for four years. Second, you will create a data visualization that summarizes these calculations.
Assume the company's discount rate of 20% (as shown in cell A9 of the above Excel screen capture) represents its opportunity cost of capital. In other words, it represents the annual return that the company could earn if it invested $100,000 in an alternative capital budgeting proposal, rather than committing it to this project's working capital needs.
Required:
1. Without considering the time value of money, how much return could Jefferson earn each of the next four years by investing $100,000 elsewhere in the company?
2. Considering the time value of money (and using the discount factors for years 1-4 as shown in the above Excel screen capture), what is the present value of the annual opportunity costs from requirement 1?
Purchase of equipment Working capital investment Annual net cash receipts Preventive maintenance Working capital released Salvage value of equipment Total cash flows (a Discount factor (20%) (b) Present value (a x b) Net present value
120,000
120,000
120,000
120,000
(40,000)
100,000
65,000
375,000
120,000
120,000
80,000
285,000
1.00000
0.83333
0.69444
0.57870
0.48225
375,000
100,000
83,333
46,296
137,442
(7,928)
