Financial Analysis of BlueScape Company - Essay Example

Finance Table of Contents Answer 4 3 Answer 5 5 References 7 Answer 4 BlueScape Company intends to spend some amount of money for the implementation of a new technology that will reduce their expenses and increase the level of profit at the same selling price per unit. There are two investments options in front of the company. First the Net Present Value of the project has been calculated using the conventional NPV method (Gallagher and Andrew, 2007, p. 269). The company had already incurred an expense on the old machine and will not get any salvage value at the end of 4 years. The unit cost of production is also high compared to the new project. The profit after corporate tax rate of 30% comes to $ 7245000. The Net Present Values of the project has been calculated by taking into account the initial investment and the cash flow streams at the end of every year and it comes to $ -28566432.13 (Kirkpatrick and Weiss, 1996, p. 15). This means that the company would not be able to break even at the end of 4 years and thus the new technology should be implemented for avoiding the expenditure burden for the company. Revenue for the company with old machine Profit before tax $ 1,03,50,000.00 Corporate Tax @ 30 % $ 31,05,000.00 Profit After Tax $ 72,45,000.00 Initial Investment $ 5,40,00,000.00 Cash Flow at the end of 1 year $ 72,45,000.00 Cash Flow at the end of 2 year $ 72,45,000.00 Cash Flow at the end of 3 year $ 72,45,000.00 Cash Flow at the end of 4 year $ 72,45,000.00 Cost of Capital $ 0.12 Salvage Value $ - NPV $ -2,85,66,432.13 In the scenario of adoption of the new technology, the company would be able to reduce the per unit production cost and as a result of which the profit for the company will increase at the same selling price of the product (Peterson and Fabozzi, 2004, p. 71). The company has to incur an initial investment of $55000000. The advantage for this project is that the company will get back a salvage value of the new machine at the end of four years and also some value from the resale of the old machine. The cash flows at the end of each year would also be more compared to the old machine. Thus after calculation of the NPV it is found that it is still negative but the figure is much better as compared to the old machine. Proposed Revenue for the company with New Machine Profit before tax $ 1,98,00,000.00 Corporate Tax @ 30 % $ 59,40,000.00 Profit After Tax $ 1,38,60,000.00 Initial Investment $ 5,50,00,000.00 Cash Flow at the end of 1 year $ 89,10,000.00 Cash Flow at the end of 2 year $ 89,10,000.00 Cash Flow at the end of 3 year $ 89,10,000.00 Cash Flow at the end of 4 year $ 89,10,000.00 Income from sale of old machine $ 1,20,00,000.00 Cost of Capital $ 0.12 Salvage Value $ 70,00,000.00 NPV $ -59,43,944.04 Funds to be taken from the Bank $ 5,50,00,000.00 interest per year $ 49,50,000.00 The financing for the new Machine can be done by selling the old machine @ $ 1,20,00,000 and the remaining amount of $ 5,50,00,000 has to be taken as a loan from a bank with a rate of interest @ 9 % pa. Thus the interest has to be deducted from the Profit before calculating the NPV of the new project (Chapman and Ward, 2007, p. 47). Thus from the above analysis it is clear that the second option available to BlueScape Company would be more feasible and they undertake the new investment on the machine. Answer 5 A large number of tools and techniques are available for undertaking the Riskiness of a project. Decision Tree Analysis: It is one of the commonly used techniques for evaluating the permeability of a project. In case of a decision tree, the projects various possible situations are calculated and their associated probabilities of occurrences are taken into consideration. Accordingly a diagram is plotted and that gives an idea of the situations that might happen due to the occurrence of a particular project and how much return it would generate for the company (Shapiro, 2008, p.146). Break Even Analysis: In this technique, the NPV at which the initial investment is recovered is calculated and that gives an idea how soon the project will start generating returns. A project breaks even at a point where the cost of goods equals the revenue earned from the goods. The earlier the option breaks even, the better it is for the company. Scenario Analysis: In case of scenario analysis, all the variables are varied at the same time and the optimistic and pessimistic options are analysed to decide whether to undertake the project (Weston, 1990, p. 305). The possible positive and negative impacts of the projects are also looked into. However the sensitivity analysis is a better tool to understand the optimistic and pessimistic situation because it gives an idea of how each of the variables is finally affecting the value of the project. Now a sensitivity Analysis is done for the investment opportunity of BlueScape Company. Since by varying the different mentioned variables like discount rate, sales, corporate tax rate, and the initial investment will have a combined effect on the NPV of the project, the variance by 10 % increase and decrease would generate the optimistic and pessimistic results for the company (Ribeiro, 2011, p. 91). Therefore, in case of the project if all the variables are increased by 10% then the Net Present Value of the project gets worse. On the other hand, if the variables are decreased then the NPV improves. Hence the cost of Capital is a factor that causes an improvement in the NPV of the project. When the discount rate is 11% the company has to incur less cost for financing the new equipment and hence it becomes an advantage for the company (Kendrick, 2009, p. 222). Again in the case of reduction of the variables by 10 % the corporate tax gets reduced by 10% and it has a positive effect on the final NPV of the investment. Hence tax rate is also another important variable that affects the Net Present Value. References Bartlett, J., 2004. Project Risk Analysis and Management Guide. Buckinghamshire: APM Publishing Limited. Chapman, C. and Ward, S., 2007. Project Risk Management: Processes, Techniques and Insights. New York: John Wiley & Sons. Cooper, D.F., Grey, S., Raymond, G. and Walker, P., 2005. Project Risk Management Guidelines: Managing Risk in Large Projects and Complex Procurements. New York: John Wiley & Sons. Gallagher, T. J. and Andrew, J. D., 2007. Financial Management: Principles and Practice. New Jersey: Pearson. Kendrick, T., 2009. Identifying and Managing Project Risk: Essential Tools for Failure-Proofing Your Project. New York: AMACOM, American Management Association. Kirkpatrick, C.H. and Weiss, J. 1996. Cost-benefit Analysis and Project Appraisal in Developing Countries. Massachusetts: Edward Elgar Publishing. Peterson, P. P. and Fabozzi, F. J., 2004. Capital Budgeting: Theory and Practice. New York: John Wiley & Sons. Ribeiro, J. M., 2011. International Development Project Appraisal, Execution Planning and Monitoring. Canada: Presses inter Polytechnique. Shapiro, A.C., 2008. Capital Budgeting and Investment Analysis. London: Prentice Hall. Weston, J., 1990. Essentials of Managerial Finance. Hinsdale: Dryden Press. Read More