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Corporate Finance Assignment - Essay Example

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1. Estimate the NPV of the project Net Present Value Net Cash Flow Net Cash Flow Net Cash Flow Particulars Initial Outlay Year 1 Year 2 Year 3 ? Initial Capital Expenditure (12,000,000) Sales 8,000,000 12,000,000 16,000,000 Variable Costs (2,400,000) (3,600,000) (4,800,000) Fixed Costs (2,000,000) (2,000,000) (2,000,000) Depreciation (4,000,000) (4,000,000) (4,000,000) Taxable Profit (12,000,000) (400,000) 2,400,000 5,200,000 Tax @ 30% 3,600,000 120,000 (720,000) (1,560,000) Amount after tax (8,400,000) (280,000) 1,680,000 3,640,000 Add back Depreciation (Non cash item) 4,000,000 4,000,000 4,000,000 Net Cash Flow (8,400,000) 3,720,000 5,680,000 7,640,000 Discounting Factor @ 8% 1 0.93 0.86 0…
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Corporate Finance Assignment
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Download file to see previous pages Sales increase from year 1 to year 2 by 1.5 times, but in the 3rd year it appears that the sales only increase by 1.33 times, which shows a decline as compared to the previous financial year. Variable cost is included as a percentage of the sales for the month, which is 30% of the sales for the year. All the fixed costs are assumed to be directly attributable to the project and thus are included in the cash flows. As mentioned in the project, the useful life of the facility will be three years, thus it will be depreciated on a straight line basis over three years. Depreciation is a non-cash item, but it is included in the cash flow forecasting because of the tax shield, since depreciation is also tax deductible. In first year, the company will have taxable loss, so it is assumed that the company will have taxable profit in the future, against which this taxable loss will be utilized, resulting in tax savings. Depreciation is added back and the net cash flow is discounted through the use of the required rate of return in order to calculate the Net Present Value. 2. The principal risk of the project There are several principal risks that surround the project. Hi-Tech Industries operates in the technology industry, which is subject to rapid changes in many fields such as standard equipment, operating procedures, and laws and regulation. The project under consideration requires a careful estimation of all the relevant costs and revenues; a misjudgment in the forecast will cause an error in the project net present value, which might result in the acceptance of a project which is not financially viable. The initial capital expenditure must be carefully projected. In order to do so, it is of prime importance that the company obtains quotations from several companies in order to project the current market value of component. An artificially higher price will put a declining effect on the net present value of the project, and an artificially lower price will cause the opposite. Another risk that is present in the financial appraisal of the project is that the company might not have estimated the correct useful life of the equipment. The IT related hardware and equipment are subject to becoming obsolete at a greater pace as compared to the other kinds, so this risk is present. While making an investment appraisal decision, it is imperative to consider the impact of inflation in the future cash flow. The information provided does not include any relevant information about the price inflation over the three year period, which can significantly impact the expected NPV. The director of the company must also consider the sources from which the financing will be obtained for the investment. Financing decision is significant, as the company would have to pay finance charge to the bank or any other financial institution, and the company must have enough cash flow in the future for the payment of these finance charge. In order to commence any investment venture, the director must receive the approval of the shareholders. ...Download file to see next pagesRead More
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