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

$ = =

Related

- 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 - 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
## 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 - Decent Essays
## Hdm 2250 Prelim Study Guide

- 4258 Words
- 18 Pages

(b) What is the NPV for both projects? If the company applies the NPV decision rule, which project should it take?

- 4258 Words
- 18 Pages

Decent Essays - Decent Essays
## Finance Mini Case Chp11

- 2716 Words
- 11 Pages

Capital budgeting is the decision process that managers use to identify those projects that add value to the firm’s value, and as such it is perhaps the most important task faced by financial managers and their staff. The process of evaluating projects is critical for a firm’s success. Capital budgeting is

- 2716 Words
- 11 Pages

Decent 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
## Don Hofstrand Capital Budgeting Simulation

- 633 Words
- 3 Pages

Don Hofstrand (2013) states that, capital budgeting that progression or technique that comprises the approximation of financial viability of the capital investment over the duration of the investment. He also states that unlike the other investment analysis techniques, it does focus on cash flows instead of profits. That is it aims at recognizing cash flow in and cash flow out. Don Hofstrand(2013) further states that there are a number of capital budgeting techniques that are at disposal to be used in the process of examining economic feasibility of a capital investment. They actually include payback period, discounted payment period, net present value, profitability index, internal rate of return and last but not least is the modified internal rate of return.

- 633 Words
- 3 Pages

Decent 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 - Satisfactory Essays
## Fin515 Week 5

- 890 Words
- 4 Pages

Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Since both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate; it will cost $22,000, whereas the gas-powered truck will cost $17,500. The cost of capital that applies to both investments is 12%. The life for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $6,290 per year and those for the gas-powered truck will be $5,000 per year. Annual net cash flows include depreciation expenses. Calculate the NPV and IRR for each type of truck, and decide which to recommend.

- 890 Words
- 4 Pages

Satisfactory Essays - Decent Essays
## Net Present Value Calculation for PowerCo Project

- 490 Words
- 2 Pages

The total NPV for the project, therefore, is $.08 million, or $80,000, based on the formula of $47.24-$47.15 (with rounding). The full calculation is shown in Appendix A.

- 490 Words
- 2 Pages

Decent Essays - Decent Essays
## The Investment Detective Case

- 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 - 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 - 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 - Best Essays
## Capital Budgeting For Airvalue Airways Essay

- 1658 Words
- 7 Pages

As is the case with any decision that involves a material investment of capital in a business, the investment must be carefully analyzed to ensure that the benefits to be derived from such an investment exceed the expected expenses in running such an expense. Capital budgeting is the process of analyzing the value that any investment will yield to the company. One of the major reasons why capital budgeting is important is because the investments involve a large cash outlay and once investment has been made the projects may not be brought to a stoop without incurring a loss to the company. In order to arrive at the best decision, all factors should be considered before

- 1658 Words
- 7 Pages

Best 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