Group Name_________________

Group No. ________

Answer Sheet for Merage Capital Budgeting Case:

Q. 1: Free Cash Flow: (1 Point)
Free cash flow is determined by adding up all the companys incoming cash and then subtract the cash
that the company is obliged to payout, which includes all expenses, debt service, preferred dividend and
capital expenditures related to the fiscal period.
The result tells us how much cash was left over or how short of cash the company was at the end of the
fiscal period.

Q. 2: Land: (1 Point)
Nothing, as it is mentioned that the value of the land will not be significantly different after 5 years so there
is no opportunity cost. The center can sale the land after 5 years. The cost has already been incurred so
need not be part of current cash outflow

Q. 3: Allocated Overhead: (1 Point)

According to the with/without principle, these allocated costs are irrelevant because the Center will have
to pay them even if the project is not undertaken .Further there are no incremental admin cost pertains to
the project arise so no allocated expenses will be included in Cash outflow.

Q. 4: Lost Current Revenue: (1 Point)

Sales erosion should be counted as relevant cost only if they are directly related to the project. In this
case the loss of sales will occur due to the new project and it is assumed that the sales erosion also
increase at the same rate as sales.

Q. 5: Market Research and Technical Feasibility Study: (1 Point)

It is a Sunk cost as they are irreverent to the decision to invest. The Center has already paid for them.
The with/without principle excludes sunk costs from the analysis of an investment. It should not affect the
decision to start the new Center.

Attach your completed spreadsheet and provide answers to essay questions on this sheet.
Q. 6: Relevant Cash Flow: (3 Points)
According to with/without principal the relevant cash flows associated with an investment decision are
only those cashflows that will change the firms overall future cash position as a result of the decision to
invest.in other words relevant cashflows are incremental or differential cashflows.

Q. 7: Payback: (1 Point)
Payback period is the time in which the initial cash outflow of an investment is expected to be recovered
from the cash inflows generated by the investment. It is one of the simplest investment appraisal
techniques.

Payback Period =

Initial Investment
Avg. Cash Inflow per Period

Q. 8: NPV (1.5 Points)

The difference between the present value of the future cash flows from
an investment and the amount of investment. Present value of the expected
cash flows is computed by discounting them at the required rate of return.
Positive NPV (i.e. Discounted Inflow > Discounted outflow) = accept the project
Negative NPV (i.e. Discounted Inflow < Discounted outflow) = Do not accept the
project
Zero NPV (i.e. Discounted Inflow = Discounted outflow) = Indifferent

Q. 9: IRR: (1.5 Points)

The internal rate of return refers to the rate which equates the present value of cash
inflows and present value of cash outflows. In other words it is the rate at which net
present value of the investment is zero. If the net present value is positive, a higher
discount rate may be used to bring it down to equalize the discount cash inflows
and vice versa. Thats why internal rate is defined as the breakeven financing rate
for the project.

Q. 10: Sensitivity Analysis: (2 Points)

Sensitivity analysis provides a way to show how a studys results would be affected
and how responsive or sensitive those results would beto changes in the values
of specific variables.
Q. 11: Scenario Analysis: (3 Points)
Scenario analysis is a strategic process of analyzing decisions by considering
alternative possible outcomes (sometimes called "alternative worlds"). It is not a
predictive mechanism, but rather an analytic tool to manage uncertainty today.
Disadvantages of Scenario Analysis:
1) Inability to accurately measure by-products of major factor movements.
2) Incorrect assumptions and correlations, user bias
NPV computed under Q No 8 is the actual base where as NPV computed under the
Scenario analysis is depending upon different outcomes.