...the problem then he told me that: His company SG group is considering to replace it’s existing machine which is not so efficient now with a new one. They have two options 1. Go for machine A which is similar to their previous machine 2. GO for machine B which is much expensive and has greater capacity. Companies cost of capital is 10%. The expected cash flow are as follows: Year | Machine A(Rs. Lakh) | Machine B(Rs. Lakh) | 1 | 5 | 10 | 2 | 10 | 15 | 3 | 20 | 16 | 4 | 15 | 20 | 5 | 15 | 15 | Cost of Machine A: 25 lakh Cost of Machine B: 30Lakh Hearing the problem I remembered that this type of problem I had studied in capital budgeting, and I asked him to relax and meet me tomorrow @ 6:00pm. SOLUTION: 1. NPV METHOD: Year | Cash Flow( Rs. In Lakh) | PVF @ 10% | Total Present Value(Rs. In Lakh) | | Machine A | Machine B | | Machine A | Machine B | 1 | 5 | 10 | .91 | 4.55...
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...Contents 1. Assignment Part A Prepare the case, with recommendations to be presented to the Board of Directors of ProGen. Assess the viability of the project using the NPV, IRR, and Payback methods. 2. Assignment Part B “The IRR rule is redundant as an investment criterion because the NPV rule always dominates. Discuss this statement giving examples where possible. 3. Conclusion “The IRR rule is redundant as an investment criterion because the net present value (NPV) rule always dominates it.” 4. Bibliography References Assignment Part A This report evaluates the viability for marketing and distribution of genetically engineered soya seeds developed by a biotechnology firm. The firm will supply seeds and permit ProGen to market and distribute them under a licence. The evaluation methods used for this proposal are net present value (NPV), internal rate of return (IRR), and Payback methods. Assumptions used for this analysis are summarised below • Marketing cost is assumed to be a sunk cost and therefore not included in the calculation • Cash flow will be considered over 5 years as this is the lifecycle of the product • An annual licence fee included at 1M per annum • Capital investment for vehicles £650k is an upfront payment and therefore not discounted • Year 5 will see a cash inflow of 120K assumed a realistic sum...
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...problem arises when it comes to how to finance the acquisition. Timken is afraid that if they take on anymore debt they will cause credit agencies to downgrade their investment-grade rating. The challenge now lies in developing a financial plan that will allow Timken Company to acquire Torrington without dropping its investment grade. II Alternative Choices 1. Finance with all equity 2. Finance with all debt 3. Finance with mixture of debt and equity Calculations to Use 1. NPV 2. WACC 3. Debt to Capital Ratio 4. EBIT Interest Coverage III. Analysis of Alternatives We first begin by accessing if the company is worth acquiring by calculating NPV using the estimated cash flows of Torrington from Exhibit 5. To use NPV we must first calculate our required rate of return. This can be done by finding the CAPM and WACC for Timken. We begin by finding the cost of debt which can be seen in Exhibit 9. Timken is rated BBB, so we can assume our cost of debt is 7.23%. Then we find CAPM to get the cost of equity. We find that the risk free rate is 5% from the treasury yield from 2002, the market rate is 10%, and the beta is 1.1 giving us a CAPM of 10.5%. We then use CAPM as the cost of equity to find our WACC. The balance sheet in Exhibit 2 shows us that we currently have 2.139 billion dollars in debt and 609 million in equity. Assuming a tax rate of 40%, our WACC is 5.7%. With this cost of Capital we can now find NPV,...
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...Internet. See examples in Chapter 1, page 22; Chapter 4, page 126. New! S&P Market Insight Problems Most chapters include two or three new end-of-chapter problems that require the use of the Educational Version of Market Insight, Standard & Poor’s powerful and well- known Compustat® database. These problems provide an easy, online way for students to incorporate current, real-world data into their learning. See examples in Chapter 3, page 92; Chapter 4, page 125. xv Basic (continued ) Intermediate (Questions 19–20) Challenge (Questions 21–23) c. If you apply the NPV criterion, which investment will you choose? Why? d. If you apply the IRR criterion, which investment will you choose? Why? e. If you apply the profitability index criterion, which investment will you choose? Why? f. Based on your answers in (a) through (e), which project will you finally choose? Why? 18. NPV and Discount Rates An investment has an installed cost of $412,670. The cash flows over the four-year life of the investment are projected to be $212,817, $153,408, $102,389, and $72,308. If the discount rate is...
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...Keesha Coaxum Ashford University BUS650: Managerial Finance Instructor Cain December 3, 2012 In this case we have four options on when to harvest next; 40, 45, 50, 55 years to see which would be the most profitable. In order to do this I will calculate the NPV of each harvest since that is the most accurate form of cost analysis (1). 40 year Harvest Revenue $39,800,250 Tractor cost 7,200,000 Road 2,700,000 Sale preparation & admin 945,000 Excavator piling 1,200,000 Broadcast burning 2,287,500 Site preparation 1,162,500 Planting costs 1,800,000 EBIT $22,505,250 Taxes 7,876,838 Net income (OCF) $14,628,413 Present Value of first harvest PV = $14,628,413/(1 + .0608)20 PV= $4,496,956 40 year interest rate 40-year project interest rate = [(1 + .0608)40] – 1 40-year project interest rate = 958.17% 40 year interest rate for Conservation fund 40-year conservation interest rate = [(1 + .0659)40] – 1 40-year conservation interest rate = 1,183.87% Present Value of thinning PV= $9,000,000/9.8517 PV= $939,286.45 Operating cash flow for 40 year harvest: $14,482,163 PV= [($14,628,413/9.5817)] / (1 + .0608)20 PV = $469,325.52 Present Value of Conservation PV = –$162,500 –$162,500/11.8387 PV= –$176.226.22 Value of Conservation today ...
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...increase after tax profit by 5%. When I did my NPV and discounted using 10% I got positive NPV so it would satisfy this constraint of 10%. How do I calculate the after tax 5% constraint? Can you please help to work with an example? You can do pro forma statements showing after tax profit before and after alternative implementation - show the % increase between the two to calculate the constraint. Hello, this might be a silly q but when I did my quants for RomaCorral I got a positive NPV for coffee shops and negative NPV's for expanding (probably did the calcs wrong). To me the Strategic Issue was to make sure we met the mandate of the 5% profit increase over 2 years and the dividends and the expanding of restaurants contributed to this big time...the coffee shops contributed to this too but very minimal. Therefore I said implement both even though the restaurant expansion had a negative NPV. Therefore the question is: do we always reject a negative NPV or if it solves the Strategic Issues do we accept the alt? I heard somewhere that this is accepted. If not accepted, then do we lose big time marks? If you get a negative NPV for an alternative, you should not be recommending it becaue at the end of the day, every company, even a non for profit, needs to be profitable to survive. If however you feel that this alternative is in fact very strong and touches on a lot of qualitative point, you may want to revisit your NPV calculation and the various assumptions that you...
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...Preparation Questions for Myers & Majluf Article on Financing and Investing Decisions Tradicional Finance a) If the NPV of the project is positive, the firm should undertake the investment. b) Base in the formula I = E + S we can demonstrate what is the best decision for the company. For that we will make a numerical example. State 1 State 2 Asset-in.place a 150 50 Investment Opportunity (NPV) b 20 10 P' I Debt (D) Lot of cash S E True Value (V) P'+E V V old new = = = 115 150 0 115 150 0 = = = = = 100 50 320 165 100 50 210 165 = 223,03 146,36 96,97 63,64 Little cash S E True value (V) P'+E V V old new = = = = 30 120 320 235 30 120 210 235 = 156,60 102,77 = 163,40 107,23 S↗ S↘ Payoff V in state 1 V in state 2 old old Issue & Invest (E=50) 223,03 146,36 Issue & Invest (E=120) 156,60 102,77 Do nothing (E=0) 150 50 With this example we can easily state that more cash bring more value to the old stockholders and most importantly, to the firm. c) Retained earnings – could avoid to issues stocks (assumption: the firm only uses risk-free borrowing to reduce the required investment and the investors are passive). “Firms should go to bond markets for external capital, but raise equity by retention if possible.” (Page 219 of the paper). Firms can build up financial slack by restricting dividends when investment requirements are modest. The cash saved is held as marketable securities or reserve borrowing power. Debt...
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... 45,000 Year 2 52,000 Year 3 43,000 If the firm has a required rate of return of 20%, should this project be accepted? a. Calculate NPV b. Calculate IRR Cfo 100000 Enter ↓ C01 45000 Enter ↓ F01 1 Enter ↓ C02 52000 Enter ↓ F02 1 Enter ↓ C03 43000 Enter ↓ F03 1 Enter ↓ NPV 20 Enter ↓ CPT NPV -1,504.63 reject NPV<0 IRR CPT 19.03% reject IRR< RROR 2. For the project above, if the firm has a required payback of 3 years, should this project be accepted? Calculate the Payback Period Year Year 1 45,000 Year 2 45,000+ 52,000 = 97,000 Year 3 3,000/43,000 = 0.0698 Payback period = 2 + 0.0698 = 2.0698 accept, since payback period < 3 years 3.Two projects are mutually exclusive. Management has asked you to decide between them. Recommend which project should be accepted and why. Project A has a cost of $400,000 and has expected cash inflows of $75,000 for 10 years. Project B has a cost of $400,000 and has expected cash inflows of $90,000 for 7 years. The discount rate for both projects is 11%. Project A CF 2nd CLR WORK CF0 = 400,000 +/-enter ↓ C01=75,000 enter ↓ F01 = 10 enter ↓ NPV I = 11 enter ↓ CPT 41,692.40 Project B CF 2nd CLR Work CFo 4000000+/- Enter ↓ C01 90000 Enter ↓ F01 7 Enter ↓ NPV I = 11 Enter ↓ CPT 24,097.66 Select A higher NPV TKM Ch12 SQ12-1. One obvious possibility is that Toyota is being paid for the technology. Although we do not know the specifics of the financial...
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...of Finance-FIN100 November 16, 2010 Explain why market prices are useful to a financial manager? The Valuation Principle states that we can use the current market prices to determine the value today of the different costs and benefits associated with a decision. A financial manager’s job is to make decisions on behalf of the firm’s investors; it also involves using skills from marketing to determine the increase in revenues resulting from advertising campaigns. Economics determine the increase in demand from lowering the price of a product, organizational behavior is used to determine the effect of changes in management structure on productivity, strategy is used to determine a competitors response to price increase, and operations are used to determine production costs after the modernization of a manufacturing plant. The financial manager’s job is to compare the cost and benefits and determine the best decision to make for the value of the firm. Discuss how the Valuation Principle helps a financial manager make decisions. The Valuation Principle helps a financial manager make decisions by the value of commodity or an asset to the firm or its investors is determined by its competitive market price. The benefits and costs of the decision should be evaluated by using those market prices, when the value of the benefits exceeds the value of the costs, the decision will increase the market value of the firm. Describe how the Net Present Value (NPV) is...
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...Ernesto Trejo 817268979 Finance 423 Tuesday & Thursday 2pm Flash Memory, Inc. Strategy Paper 1 For this company of Flash Memory Inc., there are a couple of problems the CFO must face. This company that is in the computer and electronic device market within the memory industry faces a problem with a growth rate within their company that is in result to the growing rate of the market and a result to constantly changing technologies. The other problem the company faces is the probability of accepting or rejecting an investment decision that it is faced with, that promises returns over five years, but not being able to obtain a loan from a bank. To further analyze the situation appropriately I would follow the following evaluation. Firstly Flash Memory Company must consider just how they will choose to raise funds for their possible investment, with their projected growth rate over the years they for saw a fast growing segment in market. Unfortunately they cannot issue out a loan from the bank, therefore they must come up with the sufficient funds from within. The options that they have is to either issue a form of securities to sell to the public or to contain retained earnings and reinvest into this new project line. In order to determine which is to be used they need to calculate the NPV of the future investment before they can determine how to invest in it. But the problem with Flash is that their sales are so high that more working capital is needed for the investment...
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...seminal contribution of Modigliani and Miller (1958), a key result of corporate finance theory is that a project's cash flows should be discounted at a rate that reflects the project's risk characteristics. Discounting cash flows at the firm's weighted average cost of capital (WACC) is therefore inappropriate if the project differs in terms of its riskiness from the rest of the firm's assets. (Kruger, Landier &Thesmar 2011) According to Modigliani and Miller when discounting a projects cash flows, the projects risks must be adequately reflected, in the case of New Earth Mining, the riskiness of the project is not adequately reflected. New Earth is traditionally a mining company who is traditionally a precious metal mining company; the proposed project is intended to diversify New Earth’s business operations. New Earth Mining’s operations have traditionally been central to the United States of America, and denominated in USD. The new venture is in South Africa, a completely different terrain, a different governing body, a different set of legal restraints, risk of mining a different commodity as well as a different currency namely ZAR.(West 2012) A company using a single firm-wide WACC would tend to overestimate the NPV of a project whenever the project is riskier than the typical project of the company.(Kruger, Landier &Thesmar 2011) As Kruger, Landier and Thesmar have highlighted, the proposed NPV of $83 million could potentially be overestimated. Valuation 2 The Accounting...
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...Understanding Financial Concepts – Assignment I 1. Explain why market prices are useful to a financial manager Managers are interested in market prices for reasons better explain by market of economic theory. The classic market of economic theory is a call auction market where all market participants meet in one place at one time to arrive at a market clearing price through open outcry of bids and offers. In agricultural societies, these markets were often held annually, at harvest time, but the development of futures contracts has spread commodities trading over the year. Financial markets have traditionally been open each business day. As volume in many markets has grown, efficient continuous markets - some operating on a twenty-four-hour basis - have become the norm in currencies and in a few widely held securities. In general, market forces have dealt effectively with the reallocation of price and rate risk and have provided liquidity through securitization and the allocation of capital to market making. Market forces have not yet dealt adequately with the risk of market discontinuities. 2. Discuss how the Valuation Principle helps a financial manager make decisions. The concept of value is at the heart of financial management, yet the introductory case demonstrates that valuation of companies is by no means an exact science. Inability to make precisely accurate valuations complicates the task of financial managers. The financial manager controls capital flows into...
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...IV. Capital Budgeting A. Suppose the company is considering a potential investment project to add to its portfolio. Calculate the following items: Before Home Depot calculates the net present value (NPV), internal rate of return (IRR), terminal value (TV), and modified internal rate of return (MIRR), the company must calculate its FCFs. The calculation begins by subtracting the operating costs and the 20% depreciation expenses from the cash flows derived from sales revenues. Next, the income tax (35%) is subtracted from the resulting operating income to arrive at the company’s after-tax earnings before income tax (EBIT). The final step is for Home Depot to add back the depreciation to the EBIT to arrive at the company’s FCFs. For example,...
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...Financial objectives are the specific, focused targets of the finance department/function within an organisation. Mulcahy’s financial objectives are to cut costs by 5% per annum for the next 3 years and to increase sales revenue by 20% per annum for the next 3 years. There is some tension between these two financial objectives because it is hard to increase sales revenue whilst reducing costs. One internal factor that may have influenced the achievement of both of their financial objectives is finance. Mulcahy’s prices are only mid-range and reducing that price could attract more customers to Mulcahy’s. This would further influence the achievement of increasing sales revenue by 20% per annum for the next 3 years. Although, these mid-range prices are reasonable which may effectively help Mulcahy’s achieve this financial objective. One external factor that may have influenced the achievement of both financial objectives is competition. The business does not have any unique skills which could hinder a potential customer’s choice between Mulcahy’s and a competitor. This could be a risk to Mulcahy’s achieving both of their financial objectives because if potential customers go to competitors, it is much less likely that Mulcahy’s will reach their objective of increasing sales revenue which makes it unlikely that they would also reach their goal of reducing costs. However, Molly’s skills to identify opportunities may help Mulcahy’s reduce the risk of competition and achieve their...
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...factoring department and what are the implications? After issuing the stocks, the company still needs financing. They can do it with note payable. Since the note payable to account receivable ratio less than 70%, they will end up dealing with the factoring department. And this implicates that issuing stocks is benefit to the company’s financing situation. 2. Assume Flash Memory invests in the new product line. Is it a positive NPV Investment? Given our discussions in class, estimate the WACC of the project (new product line). You will need to evaluate the WACC if Debt is used, or if new equity is issued. If using debt to get money, the WACC will be 9.88%, and the NPV of the project equals 1.44 million. If we issue stocks to get money, the WACC will be 9.66%, and the NPV will be 1.50 million. 3. What would you recommend the board to do concerning the project? Should the project be done, and if so how should it be financed? I will recommend the board to invest the project. And the board should issue new equity to finance the new...
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