Cicero Mines Investment Analysis

Part 1: Project Evaluation

When making capital budgeting decisions, there are various techniques that can be utilised. Ross et al. (2008) describes that the predominant capital budgeting methods used as being the Net Present value (NPV) method, the Internal Rate of Return (IRR) method, the Payback method, and the Accounting Rate of Return (ARR) method. Conversely, Brealey, Myers and Allen (2011) proposes that the NPV and IRR methods are considered prestige compared to the ARR and the Payback Methods, as they take into account the time value of money. Thus, the following project evaluation will focus on using the NPV and IRR methods.

NPV Method:

The Net Present Value method discounts future cash flows*…show more content…*

Thus, Cicero Mines should choose Machine B as it has a higher NPV than Machine A. It should be noted that NPV fails to account for the differing useful lives of each machine.

According to Brigham and Ehrhardt (1998) the NPV method has the capability of leading to incorrect conclusions when considering two projects with unlike useful lives. To overcome this problem, Brealey, Myers and Allen (2011) propose to convert the present value of each project to an Equivalent Annual Value (EAV). It should be noted that this method relies on the assumption that the project will be replaced with a similar cash flow pattern. Therefore in this situation, we are able to assume that both Machines A and B have the ability to be replaced by another machine at the end of the useful life. The EAV for each machine is calculated as follows:

$ = = $44,830.57

$ = =

Part 1: Project Evaluation

When making capital budgeting decisions, there are various techniques that can be utilised. Ross et al. (2008) describes that the predominant capital budgeting methods used as being the Net Present value (NPV) method, the Internal Rate of Return (IRR) method, the Payback method, and the Accounting Rate of Return (ARR) method. Conversely, Brealey, Myers and Allen (2011) proposes that the NPV and IRR methods are considered prestige compared to the ARR and the Payback Methods, as they take into account the time value of money. Thus, the following project evaluation will focus on using the NPV and IRR methods.

NPV Method:

The Net Present Value method discounts future cash flows

Thus, Cicero Mines should choose Machine B as it has a higher NPV than Machine A. It should be noted that NPV fails to account for the differing useful lives of each machine.

According to Brigham and Ehrhardt (1998) the NPV method has the capability of leading to incorrect conclusions when considering two projects with unlike useful lives. To overcome this problem, Brealey, Myers and Allen (2011) propose to convert the present value of each project to an Equivalent Annual Value (EAV). It should be noted that this method relies on the assumption that the project will be replaced with a similar cash flow pattern. Therefore in this situation, we are able to assume that both Machines A and B have the ability to be replaced by another machine at the end of the useful life. The EAV for each machine is calculated as follows:

$ = = $44,830.57

$ = =

Related

- Decent Essays
## Investment Detective

- 868 Words
- 4 Pages

In fully investigating all of our calculations we are fully invested in using the Net Present Value figures we calculated as a means of ranking the eight projects. In doing so we found reasons in which why the Net Present Value was our benchmark for ranking the projects and why we did not use the Payback Method. The Payback Method ignores the time value of money, requires and arbitrary cutoff point, ignores cash flows beyond the cutoff date, and is biased against long-term projects, such as research and development and new projects. When comparing the Average Accounting Return Method to the Net Present Value method we found that the Average Accounting Return Method is a worse option than using the Payback Method. The Average Accounting Return Method is not a true rate of return and the time value of money is ignored, it uses an arbitrary benchmark cutoff rate, and is based on accounting net income and book values, not cash flows and market values. Plain and simply put, the Net Present Value method is the best criterion to use when ranking these eight

- 868 Words
- 4 Pages

Decent Essays - Satisfactory Essays
## Answers to Mini-Case Questions

- 1823 Words
- 8 Pages

This mini-case provides a review of the methodology and rationale associated with the various capital budgeting evaluation methods such as payback period, discounted payback period, NPV, IRR, MIRR,

- 1823 Words
- 8 Pages

Satisfactory Essays - Decent Essays
## Summary Modigliani & Miller

- 1338 Words
- 6 Pages

This article mainly discusses the cost of capital, the required return necessary to make a capital budgeting project worthwhile. Cost of capital includes the cost of debt and the cost of equity. Theorist conclude that the cost of capital to the owners of a firm is simply the rate of interest on bonds.

- 1338 Words
- 6 Pages

Decent Essays - Better Essays
## Capital Budgeting Of Florida Department Of Education

- 1670 Words
- 7 Pages

Capital planning and budgeting is a very vital piece in the Public Budgeting System process. It is an essential implement in the financial management practice and is effective in both public and private organizations. It is the method which consists of the determination and the evaluation of the investments and the possible expenses by an organization. As explicate by Lee, Johnson, & Joyce (2008), capital budgets help in determining how much of each form of investment is needed, and it supports an organization in assessing the available revenue which includes loans is required to finance those investments (p. 475). Capital budgeting is a central part of the universal

- 1670 Words
- 7 Pages

Better Essays - Decent Essays
## Fina 5133 Exam 2 Review Notes Essay

- 888 Words
- 4 Pages

g. The replacement chain approach- projects with unequal lives. So with this approach, we analyze both projects over an equal life. We repeat project one to equal the life of project B to have a full comparison.

- 888 Words
- 4 Pages

Decent Essays - Satisfactory Essays
## Busn379 Week 6 Course Project Part 2 Essay

- 1346 Words
- 6 Pages

You have now been tasked with providing a recommendation for the project based on the results of a Net Present Value Analysis. Assuming that the required rate of return is 15% and the initial cost of the machine is $3,000,000.

- 1346 Words
- 6 Pages

Satisfactory Essays - Better Essays
## Fin 571 Week 6

- 2318 Words
- 10 Pages

Net present value (NPV) is the present value (PV) of an investment’s future cash flows minus the initial investment (“Net Present Value,” 2011). The high-tech alternative has a PV of $13,940,554.49 with an initial investment of $7,000,000, so the NPV = $6,940,554.49. This positive NPV indicates to

- 2318 Words
- 10 Pages

Better Essays - Good Essays
## Fin 571 Week 4

- 1710 Words
- 7 Pages

NPV is known as the best technique in the capital budgeting decisions. There were flows in payback as well as discounted pay back periods because it don’t consider the cash flow after the payback and discounted pay back period. To remove this flows net present value (NPV) method, which relies on discounted cash flow (DCF) techniques is used to find the value of the project by considering the cash flow of the project till its life. To implement this approach, we proceed as

- 1710 Words
- 7 Pages

Good Essays - Decent Essays
## Honest Vino Case Summary

- 525 Words
- 3 Pages

There are two options for the harvesters: replaced every 15 years or every 10 years. They are mutually exclusive investments having unequal lives with replacement. In order to maximise the firm value, the method of AE was used since the two projects have the same discount rate, and AE method converts the NPVs of the projects into annualised values which can be compared under this situation. The optimal option is the one with higher AE when evaluating

- 525 Words
- 3 Pages

Decent Essays - Good Essays
## Capital Budgeting For A Healthy Capital Structure

- 2163 Words
- 9 Pages

Healthy capital formation in the health care industry is crucial for organizations to achieve their long-term objectives (Cleverley, Cleverly & Song, 2010). Long-term projects require large investments and cash outlay, which precedes the receipt of cash inflow in future time (Finkler, Calabrese and Ward, 2011). Therefore, organizations tend to predict profitability by evaluating if the long-term projects expected return is great enough to justify the risk (Finkler et al., 2011). This analysis or evaluation is capital budgeting (Finkler et al., 2011). There are three approaches to assess capital budgeting, the payback method, the net value method and the internal rate of return method (Finkler et al., 2011). To understand net value and internal rate of return, acknowledgement of the time value of money is necessary (Finkler et al., 2011). However, the money needed to make these investments needs to come from somewhere. This money is referred to as capital (Finkler et al., 2011). The dominant sources of capital are stock issuance, or charitable donations (equity financing) or loans (debt financing) (Finkler et al., 2011). The choices (equity or debt) made respect to obtaining resources determines the capital structure of the organization (Finkler et al., 2011). A successful capital structure maintains the cost of capital low (Finkler et al., 2011). The cost of capital is the weighted average of the cost common stock, preferred

- 2163 Words
- 9 Pages

Good Essays - Satisfactory Essays
## FIN553 Penelope Case Group 2 Essay

- 627 Words
- 3 Pages

The third scenario was ignoring the option to invest in the second-generation project and selling the equipment in year 2. We evaluated this option as a put option. First, we calculated the probabilities for going up and down based on the assumption of a risk neutral word. As a result, the probability of going upward is calculated as 0.3375 and downward probability is 0.6625. In order to determine the present value of all the sequence cash flow at the end of year 2, we calculated the upside change rate and downside change rate as 64.87% and -39.35%, respectfully. The next step is to analyze the option value by using the “Binomial Tree” method. In order to determine the present value of all the subsequence cash flow at the end of year 2, we calculated the cash flow at each node on the tree, until 2006. We discounted all the cash flow at the risk free rate at 10%. The End of Year NPV of all the subsequence cash flow at Year 2 is calculated as $7,571,752, and the selling price of the equipment at end of 2 is $4,000,000, which is the salvage value. We found the NPV of selling the machine at end of Year 2 to be -$2,951,861 as of Year 0, which is negative. The APV of the project after adding the option turned out to be -$6,321,932. This negative APV suggest that the

- 627 Words
- 3 Pages

Satisfactory Essays - Decent Essays
## NORTHERN DRILLING INC. THE MOND NICKEL CONTRACT DECISION – A TACTIVAL DILEMMA IN A GROWTH STRATEGY

- 2970 Words
- 12 Pages

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.

- 2970 Words
- 12 Pages

Decent Essays - Good Essays
## Net Present Value

- 1958 Words
- 8 Pages

* the only justification we can think of for using the accounting rate of return method is because top management believe that reported profits have an impact on how financial markets evaluate a company. This is further reinforced in many companies by linking management rewards to short-term financial accounting measures. Thus a project’s impact on the financial accounting measures used by financial markets would appear to be a factor that is taken into account within the decision-making process.

- 1958 Words
- 8 Pages

Good Essays - Best Essays
## DECK ROMANIA CASE ANALYSES 2

- 1190 Words
- 5 Pages

Capital budgeting is the most important management tool that enables managers of the organization to select the investment option that yields comprehensive cash flows and rate of return. For managers availability of capital whether in form of debt or equity is very limited and thus it become imperative for them to invest their limited and most important resource in perfect option that could prove to beneficial for the organization in the long run (Hickman et al, 2013). However, while using capital budgeting tool managers must understand its quantitative and qualitative considerations that are discussed below.

- 1190 Words
- 5 Pages

Best Essays - Better Essays
## Project Appraisal Techniques Essay examples

- 2565 Words
- 11 Pages

There are several weaknesses with these types of analysis. First, if inflation is expected then the replacement equipment will have a higher price. Also, the sales and operating costs will change meaning that the conditions built into the analysis would be invalid. Another difficulty that could be encountered is if the replacements that occur at a future date employ a different technology which would change the cash flows. This could be fixed in the replacement chain analysis, but not with the equivalent annual annuity approach. Lastly, it is very difficult to estimate the lives of projects so this may lead to speculations about the length of these projects. Consequently, due to all the uncertainties, managers for practical reasons will assume all projects to have the same life, but a problem will still exist if mutually exclusive projects have substantially different lives.

- 2565 Words
- 11 Pages

Better Essays