BAO5534 Business Finance:Project Evaluation Report for The Executive

BAO5534 Business Finance:Project Evaluation Report for The Executive

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BAO5534 Business Finance

Questions:

Case Study

Your task as a financial analyst is to prepare a project evaluation report for the executive committee of ABC Company, indicating whether the firm should accept or reject the new project. Your report should include the answers to the following Questions 1 to 6. It is important to list your assumptions in applying the project evaluation methods and clearly show the workings in deriving your results. Your assignment will be graded on presentation, understanding of the issues, critical analysis, logical explanation, and accuracy of calculations in solving the problems. The mark allocations for individual questions (including 20 marks for presentation, writing and professional communication) will total to 100 marks and will be scaled to produce a mark consistent with 25% weighting in the unit assessment.

1. The accountant’s estimates in Exhibit 2 use the “most likely” sales projection in Exhibit 1 for each year. Are any of the 11 items listed in Exhibit 2 incorrect for application of the net present value (NPV) method? Have any relevant items been omitted from the list? Consider all information given in the case and explain why. [10 marks]

2. Prepare the incremental cash flow table which incorporates taxes and includes initial investment, operating and terminal cash flows for the project over the eight years based on the “most likely” sales projection of 1,650,000 pounds per year in Exhibit 1. Based on

your estimated after-tax net cash flows, calculate the payback period, NPV, internal rate of return (IRR) and profitability index (PI) of this project. Assume ABC uses a payback rule with cut-off period of five years and the appropriate after-tax discount rate is the company’s cost of capital. Should the project be undertaken based on each of the investment evaluation methods? [30 marks]

3. Undertake research to identify the qualitative factors that would affect the accept/reject decision of the project. [10 marks]

4. Show a sensitivity analysis of NPV to sales quantity (worst- and best-case scenarios) given in Exhibit 1. [10 marks]

5. Walker used a 12% discount rate to find the present value of annual cash flows caused by an increase in the unit sales of 3-in., 6-in., and 8-in. pipe. He believes this should be 13% and may be even as high as 15%. Does it make sense to use a higher discount rate in Question 2? How important is this “interest rate concern” to the project if the expected rate of inflation is 3% per year? Justify your answer. [10 marks]

6. Based on your answers to Questions 1 – 5 above and other information in the case, what do you recommend? Do you recommend in-house production of the 10-in. and 12-in. pipe? Defend your advice with the support of your answers. [10 marks]

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