Seller of Electricity in the United States - Essay Example

?Final Project: Power Co Introduction: PowerCo, a medium sized generator and seller of electri in the United s is aiming to build a new generator for the increased consumption of electricity in the area. In order to find how much beneficial the project will be for the company, financial projections were conducted by the treasury department. The project aims to find the feasibility of the project after a critical financial analysis. The risk inherent to implementation of the project is also being considered and the impact of the risk on the facility to be generated is also considered. The final decision underlying the acceptability of the project is considered after taking all the factors in consideration. As the project considers a period of ten years critical evaluation is required to decide the outcome of the project. Analysis: 1. The expected cost for the project: Year Expected cost(in million dollars) 1 25 2 28 Opportunity cost of the project= 8% Present value of the cost of the project: Cost (i) Discounting factor at 8 % (ii) Present value (i*ii) 25 0.926 23.15 28 0.857 23.996 2. Present value of the after tax cash profit: Year( i) Cash flow(after tax) (in million $) (ii) Discounting factor at 8% (iii) Present value(ii*iii) 3 6 0.794 4.764 4 7 0.735 5.145 5 8 .681 5.448 6 9 0.63 5.67 7 9 0.583 5.247 8 9 0.541 4.869 9 9 0.5 4.5 10 9 0.463 4.167 11 9 0.429 3.861 12 9 0.397 3.573 Total present value of cash flows=$47.244. Discounting Factor values (Present Value of an Ordinary Annuity Table, n. d) 3. Expected Net present value= Present value of the total cash inflow-the present value of the total cash outflow= 47.244-(23.15+23.996) (Kapil, n. d, p.399) = $ 0.098(in millions) As the figure here reflects a positive NPV so the project will be beneficial to the organization and should be accepted. The calculation of the Net Present Value is a method of Capital Budgeting which is done to critically evaluate the profitability behind the implementation of a new project. The positive value in the result favors the acceptability of the project. 4. Risk inherent to the project: The common risks which are associated with any business are business risk, financial risk and market risk. Business risk involves the risk under which the firm is unable to cover the operating cost associated. In the case of power Co, it is planning to install new generator thinking about the increase in demand. A study assumes that the building process will take 2 years and in the two years’ time, there will not be much inflow from the new generator involved. If the risk arises in the business that the involvement of the new project will pose a difficulty in raising the operating cost of the project, then the business runs the probability of becoming insolvent. The next type of risk which the business is likely to face is the financial risk. Financial risk involves the mode of financing for the project. The firm may be unable to meet its financial obligation for the project. In such case the debt of the firm will increase and the firm will not be able to realize the expected profit. In dealing with such kind of risk Power Co should be careful in choosing its mode of finance. It should chose an option which appears flexible for the business, it will be better if the firm chooses optimum financial mix for the purpose which should have a considerable amount of the portion of the equity. (Gitman, 2007, p.427) A portion of the equity in the financing raises confidence among the investors and also does benefit the organization in the long run. The organization is relieved of the burden of repaying the debt to some extent in case of mixed financing. The final type of risk inherent in the business is the market risk. It is to be remembered that the main reason of Power Co in opting for the installation of the new generator is the prediction of the rise in demand. Power Co forecasted that within the next ten years their rate of production will be insufficient as they are the major suppliers of electricity in the region. However the company also needs to consider the fact that the innovation in technology may give rise to substitute and in that case their forecasting may prove fatal. In order to bypass the risk the company needs to be careful in such long term forecast and should try to consider on short term planning which may seem more fruitful. In coming to a decision regarding the acceptability of the project, Power Co should analyze all the risk factors mentioned and should not be judgmental based on the financial interpretation of the results of the Net Present Value. 5. Considering the financial analysis carried out regarding the installation of the new generator the result reflected it to be favorable for the business. Figures of NPV reflected positive values which indicate that opting for the new project will do no harm to Power Co. However the estimation of the figures of profit is not real and is based on hypothesis and assumption. The organization has considered the cash flow or the profit for ten years which may not give identical values in the real time. However all the financial decisions regarding investment in new project observes the manner followed over here. The next thing regarding decision making should highlight the market point of view. As the main planning involves a strategy to reap benefits ten years down the line, so the company should be more careful in analyzing the impact of such an assignment. The organization should consider the overall implication of the economy in coming to a decision. Overall the firm can get involved in the project as the financial result reflect and since it is a sole distributor of the power supply in the area, much of difference will not create in. References Gitman, (2007), Principles of Managerial Finance, 11/E, New Delhi: Pearson Education India Kapil, S, (n.d.) Financial Management, New Delhi: Pearson Education India Present Value of an Ordinary Annuity Table, (n. d), accounting coach, available at: http://www.accountingcoach.com/online-accounting-course/present-value-of-annuity.html Read More