Questions 1. Compare the business cases for each of the two projections under considerations by Emily Harris. Qualitatively, which one do you regard as more compelling? 2. Use the operating projections to compute a net present value (NPV) for each project. Which project creates more value? 3. Compute the internal rate of return (IRR) and payback period for each project. How should these metrics affect Harris’s deliberations? How do they compare to NPV as tools for evaluating projects? When and how would you use each? 4. What additional information does Harris need to complete her analyses and compare the two projects? What specific questions should she ask each of the project sponsors? 5. If Harris is forced to recommend only one …show more content…
(Also, try to think what NWC means in our context.) Finally, compute changes in NWC from year to year. d. Finally, compute free cash flow (FCF) for each year from 2010 to 2020. e. In principle, we need to forecast future cash flows through the end of the project. What is left at the end of the project could be sold and recorded as a cash inflow at the end of the project. This inflow is called a salvage value. In this case, however, the project is assumed to last forever, i.e. there is no end date. This is very common when we value any infinitely-lived projects. In order to deal with this situation, we make an additional assumption that after some point in the future (say, 2020 for MMDC in this case), the project will become mature and it will grow at a constant rate forever. With this assumption, we can calculate the value of the MMDC project in 2020. This is called the terminal value. In other words, the terminal value represents the value, at the end of the explicit forecast period, of all cash flows occurring after that point. Assume that from 2020 onward, FCF for MMDC will grow at 3% per year. (Justify my assumption of this growth rate. Do you agree or disagree with this assumption? Why?) The terminal value, i.e. the
Thus, final free cash flows for the project come out to be $-3.750 million, $0.889 million, $2,563 million, $5,719 million and $2,388 million for years 2011, 2012, 2013, 2014 and 2015 years respectively.
4. What additional information does Harris need to complete her analyses and compare the two projects? What specific questions should she ask each of the project sponsors?
What are the expected non-operating cash flows when the project is terminated in Year 10?
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.
The first project proposal is Match My Doll Clothing line expansion consisted of expanding matching doll and child’s clothing and accessories. The second project proposal is Design Your Own Doll by creating customizable “one of a kind” doll features through the company’s website. The project selection criteria would base on quantitative and qualitative analysis. The quantitative analysis would base on the evaluation of discounting cash flow forecasts to determining the Net Present Value (NPV), Internal Rate of Return (IRR), and the Payback period of each proposed project. The qualitative analysis would include the potential project value of the company’s overall strategy, innovation, key project risks, and the project interdependencies to the whole company.
1. What is the estimated project completion date? (Assume there are no holidays and ignore the sunk cost of the planning team’s effort)
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
* A new project idea which requires an investment of $2 mm and will generate total cash flows (including any salvage or terminal value) next year of either $4mm (recession) or $8mm (boom). The firm has not yet raised the cash to make this investment, but the market is aware of the investment opportunity.
See Table 1: Expected non-operating cash flow when the project is terminated at year 4 = 165,880$
The use of an accounting rate of return also underscores a project 's true future profitability because returns are calculated from accounting statements that list items at book or historical values and are, thus, backward-looking. According to the ARR, cash flows are positive due to the way the return has been tabulated with regard to returns on funds employed. The Payback Period technique also reflects that the project is positive and that initial expenses will be retrieved in approximately 7 years. However, the Payback method treats all cash flows as if they are received in the same period, i.e. cash flows in period 2 are treated the same as cash flows received in period 8. Clearly, it ignores the time value of money and is not the best method employed. Conversely, the IRR and NPV methods reflect that The Super Project is unattractive. IRR calculated is less then the 10% cost of capital (tax tabulated was 48%). NPV calculations were also negative. We accept the NPV method as the optimal capital budgeting technique and use its outcome to provide the overall evidence for our final decision on The Super Project. In this case IRR provided the same rejection result; therefore, it too proved its usefulness. Despite that, IRR is not the most favorable method because it can provide false results in the case where multiple negative
2. Compute the NPV of both projects. Which would you recommend? What if they are not mutually exclusive?
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
5. The project is assumed to end in year 4. Do you think that this is realistic? Can you estimate the value of the project’s operating cash flows beyond year 4? State any assumptions you made.
This analysis will determine whether or not the project is worth pursuing using a net present value (NPV) approach.