Business Finance
CTUO Applied Managerial Finance Apix Risk Methodologies for Projects Discussion

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Question Description

I’m trying to study for my Business course and I need some help to understand this question.

Respond to the following scenario with your thoughts, ideas, and comments. Be substantive and clear, and use research to reinforce your ideas.

Apix is considering coffee packaging as an additional diversification to its product line. Here’s information regarding the coffee packaging project:

  • Initial investment outlay of $40 million, consisting of $35 million for equipment and $5 million for net working capital (NWC) (plastic substrate and ink inventory); NWC recoverable in terminal year
  • Project and equipment life: 5 years
  • Sales: $27 million per year for five years
  • Assume gross margin of 50% (exclusive of depreciation)
  • Depreciation: Straight-line for tax purposes
  • Selling, general, and administrative expenses: 10% of sales
  • Tax rate: 35%

Assume a WACC of 10%.

Should the coffee packaging project be accepted? Why or why not? Compute the project’s IRR and NPV.

In addition, answer the following questions:

  • Do you believe that there was sufficient financial information to make a solid decision on what to do?
  • Was there further financial information that you required that was not provided to you?
  • What financial figure do you believe was the determinant to your decision and why?
  • How would you be able to apply this particular financial information to other situations?
  • Discuss risk methodologies used in capital budgeting.

6–12 slides with 150–200 words in notes section, to include title and reference slide (not included in the deliverable)

Unformatted Attachment Preview

Benchmarking Basic Measuring and Benchmarking Techniques Overview One of the most important tasks for any marketing program is the measurement of its effectiveness. Whether using a multi-million dollar television campaign or a small, targeted direct mail solicitation, marketers must ensure that the media mix achieves its objectives. In Chang and Kelly's book, Improving Through Benchmarking (1994), the authors recommend a seven-step model: 1. 2. 3. 4. 5. 6. 7. Identify what to benchmark. Determine what to measure. Identify who to benchmark. Collect the data. Analyze the data. Set goals and develop an action plan. Monitor the process. Identify What to Benchmark Identifying what to benchmark is the critical first step in any measurement program. Marketers must clarify the objective for the benchmarking activity. Knowing the objective is key to deciding who to involve in the study, as well as the scope of the program. By setting parameters for the benchmarking study, marketers can establish a process to implement the study. Determine What to Measure Next, marketers must ascertain what to measure. In this step, marketers should consider what is important to their customers, suppliers, and partners. The client requirements—and whether they are being met—are essential to identify and document. Identify Who to Benchmark Marketers, when setting benchmark standards, should research who to benchmark and how other organizations—industry trade groups, competitors, market research firms—are making this decision. In addition, this research will reveal what method is being used to collect the data. Collect the Data 1 Benchmarking Data collection should use a process, such as a survey or questionnaire that is detailed by tasks to be completed. In addition, the measurement techniques should be outlined, assigned, and implemented. Analyze the Data Marketers must be prepared to conduct real-time analysis when the data collection process begins, to assess what changes may be required in any aspect of the measurement plan, and whether there are any gaps in the data collection process. Set Goals and Develop an Action Plan Next, marketers should be ready to set goals for the plan. These goals should be realistic, measurable, finite, and supported by the data gathered. Marketers should decide whether the goals must be met by a specific time schedule, in increments or another factor. Monitor the Process The methods to accomplish the goals influence the action plan development. The tasks, timelines, and responsibilities must be defined and should include a contingency action plan. Equally important is the action plan monitoring program. The monitoring frequency (daily, weekly, monthly), short-term and long-term goals, and the benchmark target are critical elements to the measurement plan. These basic steps outline critical functions for benchmarking and measuring the media mix for a marketing program. Mass advertising and direct response advertising integrate specific techniques into these steps to ensure that the value of unique marketing initiatives can be evaluated and illustrated. Organizations that require benchmarking and monitoring for marketing initiatives can be proactive in adjusting products or services and integrated marketing communications, and giving them a competitive edge in meeting or exceeding customer needs. Reference Chang, R., & Kelly, P. K. (1994). Improving through benchmarking: A practical guide to achieving peak process performance (Quality improvement series). Irvine, CA: Richard Chang Associates. 2 Capital Budgeting Capital budgeting is the process of making decisions about which projects to adopt and which projects to reject. The cash flows realized from the capital projects selected fuel corporate growth and drive profitability (Shaeffer, 2002). The steps in the capital budgeting process include the following (Gitman, 2006): Proposal generation Review and analysis Decision making Implementation Follow-up The actual tools used to pick the individual projects to fund include the following (Shim & Siegel, 1992; Block, Hirt, & Danielsen, 2009): Payback method Internal rate of return Net present value Accounting returns These four types of decision-making tools are divided into those that take into account the time value of money and those that do not take the time value of money into consideration. The internal rate of return and net present value take the time value of money into consideration and are also known as the discounted cash-flow methods. The other two methods, payback period and accounting returns, do not take into consideration the time value of money and are known as the nondiscounted cash-flow methods (Gitman, 2006; Block et al., 2009). The payback method looks at one key consideration: how long it will take, measured in months and years, for the net-after-cash flows generated by the project to equal the initial investment in that project (Block et al., 2009). This does not look at the time value of money and, as such, does not give a clear picture of the project’s worth because the "payback" will be in cheaper dollars than the initial outlay. Accounting returns can be based on profit derived from the project, but this method does not take into account the time value of money either and gives a somewhat distorted view of the project’s true worth (Gitman, 2006). The internal rate of return method is a discounted cash-flow technique and takes into consideration the time value of money. In this method, the yield from the project is determined by equating the interest rate that equals the 1 Capital Budgeting cash flows both in and out of the company (Block et al., 2009). This value or internal rate of return (IRR) is arrived at by trial and error until the matching rate is found. The final method used is the net present value (NPV) method. This is also a discounted cash-flow method that takes into consideration the time value of money by taking the net-after-tax cash flows expected to be generated by the project and modifying them by the net present value factor, summing them, and then subtracting the initial investment outlay. Any resulting positive answer provides a return that equals or exceeds the corporation’s cost of capital (Block et al., 2009). If there is any difference in which a project is favored between the IRR and NPV methods, the NPV method is considered more accurate. References Block, S. B., Hirt, G. A., & Danielsen, B. R. (2009). Foundations of financial management (13th ed.). New York, NY: McGraw-Hill/Irwin. Gitman, L. J. (2006). Principles of managerial finance (11th ed.). Boston, MA: Addison-Wesley. Shaeffer, H. A. Jr. (2002). Essentials of cash flow. Hoboken, NJ: John Wiley & Sons. Shim, J. K., & Siegel, J. G. (1992). The vest-pocket CFO (2nd ed.). Paramus, NJ: Prentice Hall. 2 Capital Budgeting Evaluation Techniques This article reviews capital budgeting evaluation techniques for projects that have revenue and cost streams that occur beyond the current year. Management accounting focuses on information gathering and analysis to make decisions. Some of these decisions such as CVP and pricing decisions are short term (short term means the benefits and costs are expected to last one year or less). Other decisions depend on investments that may occur in a number of years, and return benefits that also span a number of years. Capital budgeting is a tool that focuses on projects over their entire lives to consider all cash flows from a project. For example, a project to consider the purchase or construction of an expansion on a motorcycle assembly plant in Mexico would consider costs and revenues from all parts of the project, from design and engineering to construction and maintenance. During the financial evaluation phase, a manager chooses those projects with expected benefits exceeding expected costs by the greatest amounts. The most common capital budgeting method is called net present value (NPV). NPV is a discounted cash flow (DCF) technique. DCF methods incorporate the time value of money. This means $1,000 received today is worth more than $1,000 to be received in 1 year. The $1,000 to be received in one year is worth less because of the missed opportunity from not having the money today. NPV focuses on the CASH inflows and outflows (not on accounting income). NPV uses a required rate of return (also called the discount rate, hurdle rate, or cost of capital). The discount rate is the minimal acceptable rate of return on an investment. Continuing with the example of the plant expansion, NPV requires the following: • • • • 1 Identification of the relevant cash inflows and outflows Estimation of the timing of the cash flows (what year?) Discounting the cash flows to the current period (so that the time value of money is equivalent to today’s money) Summing up the discounted cash flows. Inflows will include revenues, cash from return of assets, tax benefits, and so on. Outflows will include expenses and other initial and recurring costs of the project. Discounting occurs by using a present value table, a calculator, or plain math, once the timing of each cash flow is known. Capital Budgeting Evaluation Techniques Assume the project has the following cash flows: $100,000 Investment in year 0 50,000 Additional investment in year2 75,000 Net revenue less costs in year 2 150,000 Net revenue less costs in year 3 50,000 Net revenue less costs in year 4 The discounted cash flows will be computed by dividing by 1 plus the discount rate to the power of the number of years that need to be discounted. The discounted cash flows from above are discounted as follows: Cash flow -100,000 -50,000 75,000 150,000 50,000 Year 0 2 2 3 4 Discounted form Discounted $ -100,000 -100,000 -50,000/ (1.10)2 -41,322 75,000/ (1.10)2 61,983 3 150,000/ (1.10) 112,697 50,000/ (1.10)4 34,150 Once discounted, the next step is to sum the discounted cash flows. In this example, the sum of the inflows and outflows is 67,508. As a positive amount, this means that the investment has a return of at least 10% (the discount rate). Remember that the discount rate is the minimal acceptable rate of return on an investment. Assuming a 10% return is satisfactory and not competing with other projects, the business would accept this project. To determine the exact rate of return earned, a manager would use the internal rate of return (IRR) method to figure out at what discount rate, the sum of the discounted cash flows is just zero. This means the present value of the cash outflows equals the present value of the cash inflows. The IRR is usually computed using a computer (including Excel spreadsheets). 2 Capital Budgeting The two main roles of a firm's CFO or senior financial officer are making investment decisions for improving the firm's return on equity (ROE) and finding funds for investment opportunities like new equipment, building expansions, and new products. Capital budgeting involves deciding what to invest in. Deciding how to fund the investment involves an understanding of what is referred to as capital structure. There are three primary methods of capital budgeting: • • • The simple payback method The net present value method The internal rate of return (IRR) method The net present value method involves comparing the present value of the financial benefits (increased profits, cost reductions, etc.) to the present value of the investment being considered. If the net present value is greater than zero, then the project is deemed a good investment; if the net present value is less than zero, then the project is deemed a bad investment. The internal rate of return (IRR) method asks this question: At what discount rate will the present value of the project's financial benefits equal the present value of the investment being made? This IRR percentage can then be compared to the firm’s cost of capital or benchmark hurdle rate. If the IRR is greater than the hurdle rate, then the project should move forward; if the IRR is less than the hurdle rate, then the project should not be approved. The simple payback method determines the amount of time in years or months it will take for the project to recoup its own cost in financial benefits. Each method has its pros and cons. Most small businesses, run in many cases by owner-managers, prefer the simple payback method. The calculations are very fast and easy. Corporations and privately owned firms use one or more of the NPV and IRR methods in addition to the simple payback method. To use the NPV or IRR methods, the firm’s cost of capital must be determined. Determining the cost of capital has many components, among them the expected return of each of the firm's contributors of capital (common and preferred stockholders as well as creditors, like bondholders). Asset valuation is a method to determine these various asset values, 1 Capital Budgeting which can be used to determine what the contributors of capital expect as a return. Asset values are predicated on expected future cash flows. In other words, the real value of an asset depends upon its ability to generate cash flows into the future, and the value of that asset is represented by the present value of those cash flows. For example, a preferred stockholder would value a share of preferred stock as the periodic dividend divided by the expected return, which is the basic perpetuity formula. If the face value of the preferred stock were $100 paying an 8% dividend, and the investor's expected return was 5%, the value of this share would be $100 multiplied by 0.08 and divided by 0.05 for a value of $160. This can be used to determine the preferred stockholders' expected return. The expected return equals the dividend divided by the price paid. If the stockholder paid $160 for the share, the expected return equals $100 multiplied by 0.08 and divided by $150, equaling 5%. If the investor only paid $120, the expected return when he or she made the purchase would be 6.7%. An identical calculation can be made for the expected return of common shareholders and bondholders using the dividend discount formula. This can be used to determine the discount rate to the shareholder. The formula to determine the value of a bond given a face value, a stated interest rate, and a maturity date when purchased with a stated number of years until maturity is as shown: PVbond = PV of face value upon maturity + PV of the annuity represented by its interest playments In turn, this formula can be used to get the expected return, or what is referred to as the bond's yield to maturity (YTM). 2 Investing to Meet Financial Goals Financial Goals The comprehensive financial planning process considers goals for investing planning, income tax planning, insurance planning, retirement planning, and estate planning. The financial planning curriculum includes courses that cover each of these items in greater depth, but it is important to remember the interrelated nature of the financial planning process. Some of the typical financial goals would include building an emergency fund, saving for a home, building a college fund for your children, building a retirement fund, insuring for catastrophic losses, minimizing taxes and creating an estate plan. One thing to consider in investment planning is your stage of life cycle. Your financial goals will differ based on your circumstances throughout your life. For example, some of the life circumstances may include the following: Single-adult Married Divorced Remarriage Domestic partners Parenthood Single parenthood Divorced parenthood Empty nesters Retirement In addition, your age life stage plays a major role in determining investment goals. Your goals change as you age because your needs and life situation changes. Some examples are noted below: Age and life stage Financial Goals 20s single Buy new car Create good credit rating Begin savings and investment program 20s–30s married 1 Purchase house Meet insurance needs Create wills Investing to Meet Financial Goals Save for children's education 40s Continued children's education fund Increase saving and investing Establish estate plan 50s Increase saving and investing Focus on more conservative investment strategies Increase focus on retirement and estate plans 60s Update retirement and estate plans Continual move toward more conservative investment strategies Investment Planning Investing includes forgoing immediate consumption to accumulate funds for future consumption. Thus, an investor saves or invests funds in an investment vehicle such as savings certificates, bonds, stocks and real estate to earn income and or capital appreciation. But the investment planning process will consider many factors besides growth, such as inflation, taxes, and the risks of the investment alternatives. Wealth accumulation is really about achieving goals. This includes accumulating and preserving capital while maximizing return and minimizing risk. Investing is not the same as speculating. Speculation is similar to gambling in terms of taking extreme risk to maximize returns. You can classify speculation as a highrisk investment strategy. Speculation strategies are generally short term and may include high leverage and do not attempt to preserve capital. The goal of speculation is to seek high price fluctuations over a short period of time to maximize profit. These high price fluctuations are considered very risky and are not for the average investor. In any event, investment planning strategies that build wealth must consider the following: Short- and long-term investment goals Rate of return Time horizon Risk tolerance 2 Investing to Meet Financial Goals Taxes Diversification Passive versus active management Regular investment 3 ...
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Final Answer

Attached.

Apix Risk
Methodologies
Name:
Course:

NPV and IRR
Item
Investment

• The NPV is not accepted
• NPV is presented as:
• 𝑁𝑃𝑉 = −40 𝑠𝑢𝑚𝑚𝑎𝑡𝑖𝑜𝑛 5"1"

9.72
1.1

+

5
1.1 2

0.0489 million

=-

Amount
40,000,000

5 Time (years)
sales per year
1+(5)^5

27,000,000

Gross margin
• IRR=9.956%

13,500,000

Depreciation
Profit befor tax

5

2,700,000
10,800,000

Tax

3,780,000

Profit after tax

• IRR is calculated as

7,020,000

Cash flo...

Msharon (11588)
Boston College

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