CASE 2: VALUING CAPITAL INVESTMENT PROJECTS CORPORATE FINANCE GROUP Y Growth Enterprises, Inc When valuing any project, the free cash flows must be determined in order to be able to successfully implement any method of capital budgeting. Growth Enterprises is currently considering four projects. Each has an equal required initial investment of $10,000,000 which is followed by a set of cash flows different for each project. Depreciation figures for each project were calculated on a straight-line basis. For project A, we used a one year depreciation since we were only given the first year revenue, two years for project B and three years for projects C and D. The required taxes for each project were determining by calculating …show more content…
On the other hand, when using a 35% WACC, to calculate project NPV, we would only select project D because it’s the only project with a positive NPV. When we consider the projects as mutually exclusive, then with a 10% WACC, the best project would be C with the highest NPV and a reasonable IRR. Although project D has a higher IRR than project C, we believe that a project with a higher NPV would be better since it gives us a value instead of a percentage and is considered a more accurate determinant of project value. When selecting a mutually exclusive project using a 35% WACC to calculate NPV, the best project would be D because as mentioned before, it’s the only project with a positive NPV. We can see from the analysis that once the WACC increased from 10% to 35%, the NPV’s for each project dramatically changed. Project A using 10% has a negative NPV which becomes a much larger negative NPV using 35%. At the same time projects B and C changed for positive NPV to negative NPV, which strongly influenced our project selection decisions. Finally project D maintained a positive NPV using 35% but the number got dramatically lower after using the higher WACC. (Refer to exhibit 3) We can see that when we use a higher WACC it will directly affect our project selection decisions. When a used a 10% WACC was used, the resulting NPVs offered us several attractive
1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow.
Free cash flows of the project for next five years can be calculated by adding depreciation values and subtracting changes in working capital from net income. In 2010, there will be a cash outflow of $2.2 million as capital expenditure. In 2011, there will be an additional one time cash outflow of $300,000 as an advertising expense. Using net free cash flow values for next five years and discount rate for discounting, NPV for the project comes out to be $2907, 100. The rate of return at which net present value becomes zero i.e.
Estimate the project’s operating cash flows for each year of the project’s economic life. (Hint: Use Table 2 as a guide)
Here is a rundown of the variables we used to first determine the cash flows for Years 0 through 10: depreciation of equipment over the 10 years, sales minus COGS to identify gross profit, summed expenses (advertising, start-up, and Jell-o erosion only; the test market expense in Year 1 is considered a sunk cost and thus should not be included), and subtracted taxes to come up with the cash flow. When assessing the below issues, the team concluded the following
When choosing between projects with acceptable IRRs, the one with the highest IRR should be chosen.
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
If there is no capital rationing, project B should be accepted because it has a larger net present value. If there is a capital constraint, the problem then focuses on what can be done with the additional $1,005,000 freed up if project A is chosen. If Caledonia can earn more on project A, plus the project financed with the additional $1,005,000, than it can on project B, then project A and the marginal project should be
ii-We would like to know how changing the discount rate would affect the NPV of each project. For both projects we have that as the discount rate decreases each project increases in value, and when the discount rate increases both
Each project has a WACC of 8%. Use the replacement chain approach to determine the NPV of the most profitable project.
Calculate the after tax cash flows for the project for each year. Explain the methods used in your calculations.
(TCO F) Cornell Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.
Based on the assumptions provided by the CFO, the new D/V would become 20.9% (from existing value of 9.7%). This would suggest to use the WACC calculated at 9.38% (for D/V of 20.0%). If this project were similar in risk to the firm’s current overall risk profile, this would be the WACC discount rate to apply to the project. Since Hansson believes that the risk of this project is greater than the firm’s current risk profile, we should not use the WACC value of 9.38%. We would need to apply a higher discount rate.
2. Compute the NPV of both projects. Which would you recommend? What if they are not mutually exclusive?
3. The NPV method is better because it shows the size of the project so you can see how much value a project has not just a percentage. You could have a higher percentage but a much lower value and you would still go for the lower percentage.
Mutually exclusive projects are another situation for which NPV must extend its approach. In such projects, the chosen project is usually one which results in the greatest positive NPV because this will produce the greatest addition to shareholders’ wealth. In the case of mutually exclusive investments, ranking becomes crucial as only