Case Analysis : Initial Evaluation Of Investment

1.3. In order to estimate the peso discount rate, assume that the International Fisher Effect (IFE) holds. Groupe Ariel's Euro hurdle rate for a project of this type was 8%. Assume that inflation rates are expected to be 7% in Mexico and 3% in France.

NPV analysis uses future cash flows to estimate the value that a project could add to a firm’s shareholders. A company director or shareholders can be clearly provided the present value of a long-term project by this approach. By estimating a project’s NPV, we can see whether the project is profitable. Despite NPV analysis is only based on financial aspects and it ignore non-financial information such as brand loyalty, brand goodwill and other intangible assets, NPV analysis is still the most popular way evaluate a project by companies.

Finally, in order to complete a more accurate comparison between the two projects, we utilized the EANPV as the deciding factor. Under current accepted financial practice, NPV is generally considered the most accurate method of predicting the performance of a potential project. The duration of the projects is different, one lasts four years and one lasts six years. To account for the variation in time frames for the projects and to further refine our selection we calculated the EANPV to compare performance on a yearly basis.

2. Net Present Value – Secondly, Peter needs to investigate the Net Present Value (NPV) of each project scenario, i.e. job type, gross margin, and # new diamonds drills purchased. The NPV will measure the variance of the present value of cash outflow (drilling equipment investment) versus the future value of cash inflows (future profits), at the benchmark hurdle rate of 20%. A positive NPV associated with the investment means that the investment should be undertaken as it exceeds the minimum rate of return. A higher NPV determines which project scenario will have the highest return on cash flow, hence determining the most profitable investment in terms of present money value.

Evaluating the risks, calculating the probability of success, and factoring in the projected profit from sales will provide a clearer NPV to be compared with other projects in the

7) See Table 1 NPV=42,318.71 IRR = 14% MIRR = 12% Payback period= 2.93 years. Yes the project should be undertaken.

Star Appliance is looking to expand their product line and is considering three different projects: dishwashers, garbage disposals, and trash compactors. We want to determine which project would be worth doing by determining if they will add value to Star. Thus, the project(s) that will add the most value to Star Appliance will be worth pursuing. The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.

Thus, by year three the company will be making a profit off the investment as year three is 86.73 million profit by 55.35 cost giving the company a 31.38 million dollar surplus. Generally, a period of payback of three year or less is acceptable (Reference Entry) causing this project to be viable based off the payback analysis. Although, these calculations are flawed. The reason for this is because the time value of money is not taken into effect when calculating payback periods which is where IRR can further assist in a more realistic financial picture (Reference Entry).

A project may have more than one IRR, especially when returns of an investment yield negative cash flows following positive cash flows.

In the case of Worldwide Paper Company we performed calculations to decide whether they should accept a new project or not. We calculated their net income and their cash flows for this project (See Table 1.6 and 1.5). We computed WPC’s weighted average cost of capital as 9.87%. We then used the cash flows to calculate the company’s NPV. We first calculated the NPV by using the 15% discount rate; by using that number we calculated a negative NPV of $2,162,760. We determined that the discount rate of 15% was out dated and insufficient. To calculate a more accurate NPV for the project, we decided to use the rate of 9.87% that we computed. Using this number we got the NPV of $577,069. With the NPV of $577,069 our conclusion is to accept this

4. Based on the information provided in the case, our group calculated the NPV for the project under both tax environment and tax-free condition, respectively, by using the excel spreadsheet and the NPV function. (For a detailed calculation of NPV, please refer to Appendix Under 15-yr.) According to our calculation, we have the following results: In the first case scenario, which the firm is in a tax environment (35% income tax), the NPV of the project equals to -$6,366,054.53

Internal rate of return (IRR) and Payback period “IRR of a project provides useful information regarding the sensitivity of the project’s NPV to errors in the estimate of its cost of capital” (Pierson et al.2011, pp.157).This proposal also shows the project is profitable by using Excel to get the IRR of 18.9%, which is

Overall, the ranking lists shown that the project of Strategic Acquisition should be accept by the board directors, because it has a highest IRR and NPV, the second high Profitability Index and 5 years payback, although the initial investment is really big but still the return is worse to do. The total investment of this project will be EUR55 million. The second recommend project will be the project of Southward Expansion. This project has a high IRR and NPV, the initial investment is EUR30 million, it is the 3rd in the ranking list of Project Spending and it is the 2nd in the ranking list of Project Net Cash Flow about EUR56.25 million, The payback is 5 years too. Because the project of Effuent-Water Treatment at Four Plants is highly recommend so right now we have total capital budget EUR91 million. Based on all the ranking list, the project of the Artificial Sweetener will be the last recommendation for the new year capital budget. This project has the 3rd highest IRR and NPV, the return is the 4th in the list about EUR42.75 million and payback is also 5 years. They expenditure for this project is EUR27 million. So the total budget will be EUR118 million include Strategic Acquisition, Southward Expansion, Artificial Sweetener and Effuent-Water Treatment at Four Plants.

This analysis will determine whether or not the project is worth pursuing using a net present value (NPV) approach.

The following paper analyzes a project from financial perspectives using the capital budgeting techniques like Net Present Value (NPV) and Internal Rate of Return (IRR).