Executive summary Essay Example

Table of Contents

Executive summary

A venture must be appraised with the aid of after-tax incremental cash flows. Even though zero taxes is assumed in order to focus on the approach of assessment, it just significant cash flows of the period are the after all tax effect have been taken into consideration. Net present value is an important tool for summarizing the profitability traits of a venture.

Introduction

A capital budgeting decision is distinguished from expense as well as advantage that is realized over a long period of time which would lead to the need that the time value for money be taken into consideration so as to appraise the options precisely. Even though to make an investment decision should take into consideration the risk associated with it and also time value. It is an intricate exercise to assume the time value of money, furthermore, when the cash flows are permitted to be undecided, it may imply that THE employment of the process on the initial recommendation with certainty hypothesis will lost nothing b y making the certain assumption in the forecast.

1. Incremental cash flows

The following are included as incremental cash flow analysis.

b) Working capital investment which is 10% of annual scrap revenue;

This will affect the incremental initial outlay and thus the effect in working capital changes will included in order realize an incremental initial cash outlay to be deducted from the cash flow on investment realized.

c) Annual operating costs (i.e. overheads, salaries and marketing) for each machine;

This is an operating cost that has direct impact on incremental cash flow which must be deducted from the incremental cash in order to realize the net incremental cash flows from investment.

d) The $80,000 that was spent to rehabilitate the plan

The cost of rehabilitating the plant is considered to be an incremental initial outlay which must be added to the cost of new plant in order to get net incremental initial outlay of the plant.

2. Which chip crusher (HCC or LCC) would you recommend?

Npv

The company should consider purchasing the lower-cost chip crusher (LCC)n since, it generate positive net present value which is quite more as compared to the net present value higher-cost chip crusher (HCC)

The LCC is depicting a higher IRR of 20.89% which is quite high as compared to IRR for HCC which is an Implication that an investment with high IRR would mean that the business will generate more returns within the shortest time possible.

Payback period

The LCC option will take 1.5 years to be repaid while for the HCC it will take 2.5 years to be repaid and thus the company should consider undertaking the LCC alternative since, the business will take the shortest time possible.

EAV Analysis

It can be observed that the EAV for LCC is higher as compared To the EAV for HCC which is an indication that LCC is an ideal investment alternative for the company since, the business will depict a high value of EAV within the shortest time possible.

3. Risk analysis on the project

A. sensitivity analysis of NPVs to changes in annual processed scrap revenue and cost of capita

Effect of change in Scrap revenue on Npv;HCC Option

In order to undertake the sensitivity analysis for both project, we examine the worst and best scenario which is the +20 or -20% effect on both the scrap value and the cost of capital as well as asses its impact on the net present value in terms of pessimistic (-20%) and optimist(+20%) NPV as depicted in the table below.

Variation in:	Optimistic NPV	Pessimistic NPV
Scrap value±20%	$163,585	-$120,270.00	$283,855
Cost of capital ±20%	$292,449	-$129,865	$422,314
LCC Option
Variation in:	Optimistic NPV	Pessimistic NPV
Scrap value±20%	$311,232		$262,294
Cost of capital ±20%	$292,449		$252,627

It can therefore be observed that the impact of 20% change on HCC had an adverse effect since, under the worst scenario of -20%, the company would realize negative net present value while for the worst scenario in LCC, it can be depicted that the business would still realize positive net present value which is quite low and thus , it can be concluded that the company should consider undertaking the LCC option since, under best and worst scenario, the business will still realize positive net present value which is ideal to the company in terms of positive returns.

B. how far the annual net operating cash flow could fall short of forecast before the chip crusher would be rejected

Break analysis entails the assessment of the extent to which the company can operate before to earn no profit or loss. It is therefore the point at which the net present values equal zeros. From the analysis, it can be observed that LCC option will withstand 26% decline in revenue to $300,000 while for HCC will turn to be un foreseeable where the revenue declines to 260,000$ which implies 29% decline where the expense will grow by 33% to 330,500$. While LCC is combined utmost operating cost of $200,000. It can therefore be concluded that the LCC is not be susceptible to changes in variables which is an indication that the company should consider undertaking the LCC alternative due to small change on NPV.

C. Effect of inflation {2.5% per annum.}

The effect of inflation is that it will lead to an increase in operating cost with a decline in value of net realized form the venture and as a result, the breakeven point will reduce to a lesser units since, the time it takes for the NPV to equate to zero will be less due to less sales volume realized due to inflation growth by 2.5%. The value released in the breakeven point above wills therefore reduced by the same amount of inflation growth which is an indication that the inflation has direct impact on sales and cost and hence the breakeven point.

4. Which chip crusher (LCC or HCC) they to invest

Taking into consideration all of the above factors that affect the business, the company therefore consider investing on LCC since, it will take the shortest time possible before the returns is realized to the investors as well as it depict a higher value of Net present value unlike the values for HCC.

5. Reasons for your recommendation and any reservations

The sensitivity analysis performed on the two alternatives depict that the company should invest in LCC because, there is small variation cause by the change in cost of capital and scrap value to Net present value unlike the sensitivity analysis for HCC which depict a negative NPV under the pessimistic NPV. A project with shortest time would therefore depict less variation due to less uncertainties associated with forecasting the cash flow unlike the longest time forecasting which will be affected by future uncertainties And thus the project is susceptible to uncertainties as observed for HCC which has project life span of 6 years while LCC is 4 years implying less variation consequential from shortest forecast.

Reservation

Holding other factors constant, the project forecast is assumed to be precise and thus the external factors such as fierce completion and available market for the business will not affect business operation and thus the business operate into unforeseeable future. The forecast and sensitivity analysis on the project is therefore made on assumption basis and not based on real life situation in this regards. The outcome will not be exact but we are 95% confident that the outcome will be achievable and significant for our analysis and investment decision making that is deem viable for the business growth as for the case of NOVA tractors limited.

Appendices

Depreciation
	(500,000*0.4)	300000*0.4	180000*40%	72000*40%
Depreciation	-200,000
Net book value
After tax sales
Net of tax (0.7)
Net of tax
After tax operating costs
Annual Operating cost
						1421.568
Capital Gain
Net book value
Residual value
Capital Gain
	-10389.6
Working capital changes
10% of scrap	(45000*10)

NOVA TRACTOR CORPORATION Incremental Cash Flow Table
Purchase cost		-$500,000
Working capital changes
Tax saving from govt. investment allowance	(200000 x 11%) x 30%
Redundancy payout avoided		$100,000
Tax savings from depreciation expense	(500000 * 40%) x 30%	-200,000
After tax sales	Sales before tax x (1 — 30%)
After tax operating costs	40% x after tax sales
Sale of fabrication machine
Tax paid on capital gain from sale of machine	30% tax rate x capital gain	(0.3*34632)						-$10,390
Annual after-tax net cash flows		-$388,900		$315,720
	Company RoR, or WACC
	Net Present Value (NPV)	$261,600.38
	Profitability Index
	Internal Rate of Return (IRR)

Lower-cost chip crusher (LCC)

Depreciation
	(400,000*0.35)	260000*0.35	169000*35%	109850*35%
Depreciation	-140,000			-38447.5
Tax saving 30%
				-11534.3
After tax sales
Net of tax (0.7)
Net of tax
After tax operating costs
Annual Operating cost
Capital Gain
Net book value
Residual value
Capital Gain
Working capital changes
10% of scrap	(25000*10)

Incremental cash flow (LCC)

NOVA TRACTOR CORPORATION Incremental Cash Flow Table
Purchase cost		-$400,000
Working Capital Changes
Tax saving from govt. investment allowance	(200000 x 11%) x 30%
Redundancy payout avoided		$100,000
Tax savings from depreciation expense	(500000 * 40%) x 30%				-11534.3
After tax sales	Sales before tax x (1 — 30%)
After tax operating costs	40% x after tax sales
Sale of fabrication machine
Tax paid on capital gain from sale of machine	30% tax rate x capital gain	(0.3*34632)				-$15,995
Annual after-tax net cash flows		-$290,900	$198,800	$178,220	$140,903	$114,438
	Company RoR, or WACC
	Net Present Value (NPV)	$558,014.00
	Profitability Index
	Internal Rate of Return (IRR)
NOVA TRACTOR CORPORATION: Calculating the EAV for two projects of unequal lives
HCC project with 6 years of cash flows
From the earlier incremental cash flow table…
	0
Annual after-tax cash flows	($388,900)		$315,720
Company RoR
Net Present Value (NPV)	$261,600.38
	$72,570.49	Cell formula: =pmt(rate, number of payments, -NPV,0,0)
NOVA TRACTOR CORPORATION: Calculating the EAV for two projects of unequal lives
HCC project with 4 years of cash flows
	0
Annual after-tax cash flows	($290,900)	$198,800	$178,220	$140,903	$114,438
Company RoR
Net Present Value (NPV)	558,014.00
	$183,717.42	Cell formula: =pmt(rate, number of payments, -NPV,0,0)

Sensitivity Analysis

HCC Alternative

NOVA TRACTOR CORPORATION Incremental Cash Flow Table;optimistic change (20% increment in scrap value)

Depreciation

Purchase cost

-$580,000

Working capital changes

(500,000*0.4)

300000*0.4

180000*40%

72000*40%

Tax saving from govt. investment allowance

(200000 x 11%) x 30%

Depreciation

-200,000

Redundancy payout avoided

$100,000

Net book value

Tax savings from depreciation expense

(500000 * 40%) x 30%

-200,000

After tax sales

Sales before tax x (1 — 30%)

After tax sales

After tax operating costs

40% x after tax sales

Disposal

Net of tax (0.7)

Tax paid on capital gain from sale of machine

30% tax rate x capital gain

(0.3*34632)

-$10,390

Net of rax

20% increment

Annual after-tax net cash flows

-$468,900

$364,720

$114,088

Net sales

Company RoR, or WACC

After tax operating costs

Net Present Value (NPV)

$83,584.61

Annual Operating cost

Profitability Index

1421.568

Internal Rate of Return (IRR)

Capital Gain

Net book value

Residual value

Capital Gain

-10389.6

Working capital changes

(45000*10)

10% of scrap

HCC Alternative NOVA TRACTOR CORPORATION Incremental Cash Flow Table;pessimistic change (-20% increment in scrap value) Depreciation Purchase cost -$580,000 Working capital changes (500,000*0.4) 300000*0.4 180000*40% 72000*40% Tax saving from govt. investment allowance (200000 x 11%) x 30% Depreciation -200,000 Redundancy payout avoided $100,000 Net book value Tax savings from depreciation expense (500000 * 40%) x 30% -200,000 After tax sales Sales before tax x (1 — 30%) After tax sales After tax operating costs 40% x after tax sales Disposal Net of tax (0.7) Tax paid on capital gain from sale of machine 30% tax rate x capital gain (0.3*34632) -$10,390 Net of rax 20% increment Annual after-tax net cash flows -$468,900 -$43,200 $266,720 Net sales Company RoR, or WACC After tax operating costs Net Present Value (NPV) -$209,865.50 Annual Operating cost Profitability Index 1421.568 Internal Rate of Return (IRR) Capital Gain Net book value Residual value Capital Gain -10389.6 Working capital changes (45000*10) 10% of scrap