Big Bang Ltd is considering to invest in one of the two following projects to buy a new equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 8%. The cash flows of the projects are provided below. Equipment 1 Equipment 2 Cost $186,000 $195,000 Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5 86 000 93 000 83 000 75 000 55 000 97 000 84 000 86 000 75 000 63 000 Big Bang’s net income in current year is $450,000. The company maintains a capital structure of 55% in equity funding and 45% in debt funding.
Big Bang Ltd is considering to invest in one of the two following projects to buy a new equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 8%. The cash flows of the projects are provided below. Equipment 1 Equipment 2 Cost $186,000 $195,000 Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5 86 000 93 000 83 000 75 000 55 000 97 000 84 000 86 000 75 000 63 000 Big Bang’s net income in current year is $450,000. The company maintains a capital structure of 55% in equity funding and 45% in debt funding.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Question
Big Bang Ltd is considering to invest in one of the two following projects to buy a new equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of
|
|
Equipment 1 |
Equipment 2 |
|
Cost |
$186,000 |
$195,000 |
|
Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5 |
86 000 93 000 83 000 75 000 55 000 |
97 000 84 000 86 000 75 000 63 000 |
Big Bang’s net income in current year is $450,000. The company maintains a capital structure of 55% in equity funding and 45% in debt funding.
Required:
- Identify which option of equipment should the company accept based on
NPV method. (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification) - Identify which option of equipment should the company accept based on Profitability Index method. Which equipment option should the company finally choose if the company is facing soft capital rationing?
- How much dividend Big Bang Ltd can pay its shareholders given the chosen project you decided in question (c) and if the Residual Dividend Payout Policy applies?
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