IRR Calculation

timer Asked: Nov 11th, 2016

Question description

Just need to add a calculation for IRR on my case study plz, nothing else to do...

DHARHAN ROADS 1 Dharhan Roads Case Study Antoine Babala Matwan Dallas Baptist University DHARHAN ROADS 2 Dhahran Roads Case Study Executive Summary Hassan Malik received fax notification seeking their interest in the development of road network that linked the entire city and airport terminals. However, they found that the anticipated venture would only return them fifteen percent return, against their required eighteen percent they usually make in projects of that nature, owing to the risks and uncertainties involved. The mail had asked SADE construction firm to respond to the mail within a week, so as to indicate whether they would take up the project. The terms of the project came in various rules, the first one that mandated SADE Corporation to bill the ministry according to the milestones they obtained each year, for the fiveyear period of the contract. The ministry would have advanced the firm at least fifteen percent of the total value (168Million), as a sign of commitment. According to Pinson, (2008), the company would bill the ministry annually, whereas the ministry would, in turn, pay eighty percent withholding twenty percent. All payments will only come after an inspection of the site if it meets the specified requirements of the ministry. The ministry withheld the twenty percent following; the recovery of the first fifteen percent paid in advance, and accumulation fund retention. Because the project would get completed in 1997, the project retention fee would get paid in half of the withheld five percent. Then, the remaining bit of the 5 percent would get remitted in a year’s time after the commencement of the road to account for any flaws that would arise (Pinson, 2008). After the survey of the project by SADE officials, they found that the project entailed no uncertainties as it portrayed no differences from the previous projects that they had completed. DHARHAN ROADS 3 They, therefore, realized that the internal rate of return of the project had an enormous potential. That gave them the moral to initiate the start of the project. As earlier mentioned, the project would take up at 146 million, with 38 million getting used in the acquisition of equipment as soon as the project commenced. Pinson, (2008) suggested that the equipment had a zero downside upon the completion of the project. The first seven million would get applied in surveys of the place, to assist in determining the uncertainties and risk that the project would generate. The purchase of the item would be held within the first year at the cost of thirty-eight million, and anticipated no time sensitivity analysis risk. The banks were willing to advance SADE a loan of four million that they would commit for the whole five years duration of the project. According to Rohrich, (2007), at a twelve percent interest, SADE still experienced no uncertainties, owing to the amount of profit they anticipated to obtain from the venture. The overall project got managed by highly skilled personnel who would, in turn, ensure that they deliver within the timeframe, due to the money aspect of time. Decision Problem Hassan Malik has a week to respond to the project proposal (Bodily, Carraway, Frey, & Pfeifer, 1998). Should SADE accept the contract or not? Decision and alternatives Hassan Malik have to evaluate if the project would still be acceptable despite the fact that it will provide only 15 percent return, instead of the 18percent required. Each project has its points of weakness or threats, despite suggesting the possibility of running smoothly. Out of experience from prior projects, Malik spotted the two most important DHARHAN ROADS 4 points that acted as potential risks to the success of the project. In spite of working within the set time frame, late payments from the clients may slow down processes that require cash to move to the next steps. Secondly, cost overruns is another aspect of what might get one into trouble. The dangers of cost overrun include eating into the firm’s profits or failure to make payments to workers. Worst of all is the inability to acquire the basic products needed to run the project. Delayed payment schedules took place especially when customers in question had the thought that the project had reached a critical stage and the contractor had committed themselves and would not afford to leave the project incomplete. The delays occasionally showed up in the second year and became worse as the project progressed onto the third year and so on, from the patterns, (Rohrich, 2007). Discussions showed that project delayed payments lasted at least a year, thereby recurring in the subsequent years. Delays occurred in at least thirty percent of their recent ventures, posing a significant threat to their future projects. They thought that clients intentionally did that act, even when the project was almost. The studies as to the cause of the delayed payments came due to two elements; one was whether the client noted that the contractor veered from their specifications, and the other was if the customer noted a discrepancy in invoicing. They would not raise funds as use that as an excuse, putting the contractor in a big fix. Nearly all the delays they experienced were projects reached the third stage, with twenty percent in the second year. Cost overrun was another problem that emerged when a project required more cash than got anticipated by the firm in their initial projection. Peterson, and Fabozzi, (2009), cost overruns DHARHAN ROADS 5 would emanate from various aspects, for instance, a change in the design of the project would result in more funds to meet the new specifications, and else things would not work as expected. Alternatively, planning or failure to plan adequately may alter the cost of processes or funds required to meet certain obligations. The reason for that being that, reduced time frames from the initial plan would need more cash to meet the obligations earlier than anticipated. Unlike the case when things went on the right was as they got monitored, (Peterson, & Fabozzi, 2009). The calculations would take place as follows: SADE construction firm would have received a 15% payment at the start of the contract. The 15% advance payment would act as a down payment or a commitment fee by the client =15/100 X 146,000,000 Initial commitment fee is 15% which is RS. 21,900,000.00 The accomplishment of each milestone would attract an 80 %, which would take place, as soon as each milestone gets achieved. Out of the 100%, the 80% gets paid upon satisfying the inspection requirements The remaining 20% gets withheld for two reasons. 1. A recovery of the 15 % initial payment deposit. 2. Accumulation of a retention funds From the 20%, 15% gets recovered as a prepayment, then the second 5% gets recovered in two portions. DHARHAN ROADS 6 First half of 5% goes gets paid as soon as the project gets completed. The second portion of the 5% gets recovered after a year, when the project did not indicate any sort of problem within a year of use. Profit calculation: The firm would obtain 15 % gross profit from the venture, as follows 1.18 X 146,000,000 Amount collected in form of payments= RS. 168,000,000 Profit= 168,000,000-146,000,000= RS. 22,000,000 The firm would have to part with the loan recovery of the RS.4, 000,000 took from the bank at the end of 1997. Net present value Net present value of the equipment applied in developing the road cost 38 million and got acquired as follows. The item would cost 38 Million, but the manufacturer would allow at least 75 % of the cost on order placement 75/100 X 38 Million = 28,500,000 The remaining 25 % would get completed when the equipment gets delivered Cost of project: The project would cost 146,000,000 outlined as follows DHARHAN ROADS 7 Cost of equipment = 38,000,000 Preliminary site work = 7,000,000 Subsequent amount spent in 1994 = RS. 25,000,000 Subsequent amount spent in 1995= RS. 29,000,000 Subsequent amount spent in 1996 = RS. 27,000,000 Subsequent amount spent in 1997 = RS. 20,000,000 The total amount spent include = (20 + 27+ 25+29+7+38) Million spread over the five years. Total expenditure= RS. 146,000,000.00 Outstanding loans: 4 Million Spread in four years at 12 Annual interest Year one= 4 X 1.12 = 4.48 Million Year two = 4.48 X 1.12 = 5.0167 Million Year three= 5.0167 X 1.12 = 5.6197 Million Year four = 5.6197 X 1.12= 6.2940 Million The total amount payable for the loan in four years = 6.2940 Million Payment delays: From the first year, No delay took place Second year = 20 % delayed payments occur DHARHAN ROADS 8 Third year = 80 % of projects In total delays occurred in 30 % of projects Conclusion The project would still generate income for SADE Corporation because the organization would experience a tax relief on the contract, a high internal rate of return since the equipment indicated no salvage value after the project duration. Project failures or problems likely to impede the success of any given project would rely on the profound communication corporation between the client and the contractor. The other portion relies on the contractor to monitor the costs of each aspect and stage so that they don’t overrun. The monitoring process is crucial in determining the success level of a project. DHARHAN ROADS 9 References: Peterson, D. P., & Fabozzi, F. J. (2009). Foundations and applications of the time value of money. Hoboken, N.J: John Wiley & Sons. Pinson, L. (2008). Anatomy of a business plan: A step-by-step guide to building the business and securing your company's future. Tustin, CA: Out of Your Mind & into the Marketplace. Rohrich, M. (2007). Fundamentals of investment appraisal: An illustration based on a case study. Place of publication not identified: R Oldenbourg Verlag Gmbh. Bodily, S. E., Carraway, R. L., Frey, S. C., Pfeifer, P. E. (1998). Quantitative Business Analysis: Text and cases. Boston, Mass: Irwin/McGraw-Hill.
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